Carrying flags bearing slogans like "Refugees not welcome", the crowd chanted "Merkel must go" as they railed against the almost 900,000 asylum seekers who arrived in Germany last year.
No violence had broken out so far at the rally, police said, while independent research group Durchgezaehlt estimated turnout at between 6,500 and 8,500 people -- far less than the 20,000 who joined the anniversary rally a year ago.
Pegida was forced to hold its anniversary gathering this year rather than -- when it usually holds its rallies, because two public events aimed at countering the Islamophobia group had already reserved the space in Dresden's old town.
City authorities were to hold a festival for residents , while an anti-Pegida group had also called a rally at the same time to "send a sign against the hate" spouted by Pegida.
Short for "Patriotic Europeans Against the Islamisation of the Occident", Pegida was born in October 2014 with xenophobic marches every evening.
At its peak the group attracted 25,000 to its protests in January last year before waning as its founder Lutz Bachmann was caught making overtly racist comments and as "selfies" of him sporting a Hitler-style moustache and hairstyle surfaced.
Bachmann was in May convicted of inciting racial hatred and fined nearly 10,000 euros for branding refugees "cattle" and "scum" on social media.
In early October, Pegida supporters sparked outrage when they heckled Chancellor Angela Merkel and President Joachim Gauck during German reunification celebrations in Dresden.