The dollar advanced against the yen and the euro on Friday as investors resumed pricing in the possibility that the Federal Reserve will begin to pare back its bond-buying program as soon as its September policy meeting.
Fed Governor Jeremy Stein on Friday highlighted September as a possible time when the U.S. central bank will need to consider reducing its 'quantitative easing' economic stimulus program.
Stein said the Fed's eventual decision to scale back its $85 billion in monthly asset purchases must be based on the overall economic progress since it launched the stimulus and not be "excessively sensitive" to the most recent economic data.
"Stein's remarks cannot be lightly dismissed and raise risks that some on the Committee may have already essentially decided on September," said Michael Feroli, economist at JP Morgan in New York.
"More generally, compared to remarks from Fed officials earlier this week, Stein's speech was less geared toward calming market perceptions of Fed policy and did less to question market pricing of the first rate hike."
(Read More: Data Clear Some Doubts Over Japan's Policies)
JPMorgan in the past had said that the first 'taper' from the Fed would be a close call between September and December. But since first-quarter U.S. economic growth numbers and potentially second-quarter figures could show low growth, the U.S. bank said the Fed could reduce easing in December.
The dollar got an added boost on Friday when a report showed U.S. consumer sentiment improved in late June, ending the month close to a near six-year high set in May, as optimism among higher-income families rose to its strongest in six years, a Thomson Reuters/University of Michigan survey showed.
Volume in dollar/yen surged to US$4.0 billion as of late afternoon trading in New York, while turnover in euro/dollar was US$4.3 billion.
For June, the dollar fell 1.2 percent against the yen, snapping eight straight months of gains against the Japanese currency, while the euro was little changed against the dollar.
"We are settling into the bottom of the recent range (on euro/dollar) at around $1.3000," said Andrew Dilz, foreign currency trader at Tempus Inc. in Washington, "but there is no reason not to be trading at $1.3000."
Richmond Fed President Jeffrey Lacker said from West Virginia on Friday that financial markets should brace for more volatility as they digest news that the Fed will scale back bond buying later this year, but added it was an understandable adjustment and will not derail growth.
Investors were also beginning to speculate about what announcements may come from the European Central Bank policy meeting next Thursday.
Analysts said growing worries about the euro zone's faltering economy, in contrast to the relative optimism around the U.S. economy, could hurt the bloc's common currency.
This week ECB President Mario Draghi cited downside risks to growth and said the bank was nowhere near exiting its accommodative monetary policy.
"We think President Draghi will use more dovish language in the statement and during the press conference that will highlight the growing prospects of further easing measures, including negative deposit rates," said CitiFX in a research note.
The Bank of England, Reserve Bank of Australia and Sweden's Riksbank will also hold monetary policy meetings next week.
"There is speculation that the ECB may do outright quantitative easing," said David Song, currency analyst at DailyFX in New York.
While the Fed's asset purchases have weighed on the dollar, Song said investors would take it as a positive sign if the ECB ramped up efforts to stoke growth in Europe.
"There is a little bit of a different dynamic on the two currencies," Song said.
Other analysts cautioned that quarter-end flows were creating some distortion in market sentiment.
Large funds rebalance their investment portfolios at the end of each month and quarter, so their flows and requirements to square positions often dominate trade on the last trading day.
The Australian dollar was last down 1 percent against the Canadian dollar at C$0.9619 and touched a session low of C$0.9607 after the release of IMF data on central bank holdings, which for the first time separated reserves in the two commodity bloc currencies as individual line items.
Central banks held US$98.66 billion in the Australian currency globally as of the first quarter, or 1.63 percent of allocated reserves. They held US$94.93 billion in Canadian dollars, or 1.57 percent of known reserves.