Gold hit its highest in two months on Friday as the dollar fell and a global flight from emerging market assets set global stock markets on course for their worst week so far in 2014.

The U.S. currency registered its biggest one-day drop in three months, leaving bullion in line to post a fifth week of gains.

Spot gold was up 0.6 percent at $1,271.41 an ounce at 1225 GMT, reversing from a fall earlier in the day and touching$1,272.70, its highest since mid-November. U.S. gold futures for February delivery gained 0.7 percent to $1,272.10.

"General sentiment on equity markets has been quite downbeat, but the biggest factor here by far is the dollar," Andrey Kryuchenkov, an analyst at VTB Capital, said.

"There's still room for growth with more short-covering. The market could well push toward $1,280 and $1,290 before coming lower. Gold will come down before the Fed," he added, referring to next week's U.S. monetary policy meeting.

Gold prices had rallied more than 2 percent on Thursday as a drop in the dollar and a call from India's ruling party chief to review import restrictions on bullion prompted a spate of short-covering.

Gold is on track to record a fifth straight weekly gain for the first time since September 2012.

But investors are still wary of a market that took its biggest tumble in more than 30 years in 2013.

The world's largest gold-backed ETF, New York's SPDR Gold Shares, said its holdings declined by 5.4 tonnes on Thursday, bringing its outflow for the week to 6.6 tonnes. It logged its first weekly inflow since early November last week.

Chinese demand eased, with premiums on the Shanghai Gold Exchange dropping to $10 an ounce from $12 the previous day. China in 2013 took over from India as the world's leading consumer of gold jewellery, data from metals consultancy Thomson Reuters GFMS showed.

INDIAN GOLD PREMIUMS FALL

Gold premiums in India, the second-biggest buyer, fell more than 30 percent on Friday from earlier this week on speculation over a possible easing of restrictions on bullion imports.

Premiums were quoted at $75-$85 an ounce on London prices on Friday, compared with $110 on Wednesday.

Sonia Gandhi, leader of the ruling Congress party, was reported on Thursday to have asked the government to review import restrictions, which sharply cut supplies available to India's bullion dealers last year.

UBS said that while any significant change in the regulatory environment is probably unlikely until after elections due by May, many market participants expect some adjustments.

"Any changes are likely to be introduced only slowly, in our view, thus allowing the government time to assess the impact on gold flows, the current account and, to an extent, the rupee," the bank said in a note to clients.

Among other precious metals, platinum fell 0.3 percent to $1,450.50 an ounce as traders bet strikes in South Africa's platinum mining sector would be less damaging than feared.

Spot silver rose 1.3 percent to $20.21, taking a lead from gold, while spot palladium was flat at $740.50 an ounce.