NEW YORK (Reuters) - The US dollar rallied to a three-week high against the yen on the first trading day of 2009 on Friday after a strong performance on Wall Street encouraged risk appetite.

The dollar also gained versus the euro, after data showed deepening recession in the euro zone and as traders deemed the euro's rapid advance last month was overdone. Thin holiday trading volumes may have exacerbated currency moves, analysts said.

"The rise in stocks here in the US and globally, at least for now, has increased risk appetite," said Omer Esiner, senior market analyst at Ruesch International in Washington. "Dollar/yen has benefited from that, particularly in holiday thin trade."

Risk aversion has seen the low-yielding yen soaring over the past year, with the dollar losing more than 18 percent versus the Japanese unit, its worst annual performance since 1987. An improvement in risk appetite tends to be associated with yen-selling.

In late trading in New York, the dollar was last up 1.6 percent at 92.22 yen , after trading as high as 92.40, the highest level since mid-December.

The euro fell 0.9 percent against the dollar to $1.3862, having earlier hit a session low of $1.3841.

"The dollar was beaten up pretty badly late in December and that move got carried away, particularly against the euro. That move was a bit too severe given the economic outlook in the euro zone and the likelihood that the (European Central Bank) is going to be lowering interest rates," said Stephen Malyon, chief currency strategist at Scotia Capital in Toronto.

Investors have shunned the dollar and shifted into euros recently as the US Federal Reserve cut interest rates to near zero, while the European Central Bank has adopted a more gradual approach to cutting interest rates.

"I'm not surprised really to see the dollar pull back a little bit of ground, but the market right now is so illiquid that it's very hard to attribute currency moves to any real fundamental factors," Malyon said. Further adding pressure to the euro was data released earlier on Friday showing euro-zone manufacturing activity fell to the lowest in the survey's 11-year history.

Meanwhile, sterling resumed its downtrend in choppy trade, after data painted a gloomy picture of the UK economy.

The pound was last down 0.7 percent against the dollar at $1.4509.

The euro pared earlier gains and recently traded up 0.1 percent versus sterling at 95.50 pence . The pair had hit a record 98.05 pence earlier this week, within striking distance of parity.

British mortgage approvals for house purchases fell to a record low in November , while a separate Bank of England survey showed credit conditions looked set to tighten further in the next three months House prices also fell by a bigger-than-expected 2.2 percent in December.

The figures reinforced expectations the Bank of England will cut key interest rates by at least 50 basis points next week from the current two percent.

"US dollar has yet to garner fresh gains versus the pound as the Bank of England is widely expected to resume its easing campaign as early as next week with a possible 75 basis points rate cut," said Ashraf Laidi, chief market strategist at CMC Markets in London, wrote in a note.

In the US, the dollar briefly pared gains after an industry report showed factory activity fell more than expected to a 28-year low in December.