The euro rose against the dollar on Wednesday, along with growth-linked currencies on speculation the US Federal Reserve will adopt further monetary stimulus, although any disappointment would leave them vulnerable to a selloff.
The euro also gained some support from signs that Greek parties may be close to forming a coalition government and expectations that euro zone policymakers could take quick steps to lower borrowing costs for Spain and Italy.
Strategists said the Fed’s policy decision due later on Wednesday would take centre stage and the common currency could be rangebound between $1.26 and $1.2750 in the run up to it.
The euro was up 0.1 percent at $1.2700, not far from a one-month high of $1.2748 hit on Monday after a narrow win for pro-bailout parties in the Greek election. It clung on to much of the gains made against the dollar on Tuesday.
“The weakness in the dollar is understandable but once that speculation is out of the way, and we know what the Fed are going to do, concerns about the euro zone will come back to the fore,” said Simon Derrick, head of currency research at Bank of New York Mellon.
Signs the euro zone debt crisis is intensifying - through weakening German economic indicators and elevated Spanish bond yields - have prompted some players to bet central banks will step in with measures to safeguard global growth.
Many investors doubt the Fed will go so far as to launch another round of quantitative easing, a policy that entails the expansion of its balance sheet via bond purchases. But there might still be some disappointment if the Fed holds off such stimulus.
A more likely scenario is for the Fed to extend “Operation Twist”, a programme aimed at pushing down long-term borrowing costs by selling short-term securities to buy longer-term ones. The scheme is now due to end in June.
The dollar was slightly lower on a basket of currencies at 81.358, not far from a one-month low of 81.186 hit on Tuesday.
Peripheral debt pressured
The greenback’s overall weakness saw sterling trade near a one-month high at $1.5735, despite minutes from the latest meeting of the rate-setting committee of the Bank of England showing that policymakers are on the verge of another round of monetary easing in the UK.
Bank of England’s Mervyn King has flagged the downside risks to the economy from the euro zone turmoil and analysts said decisions to ring fence the UK from Europe’s troubles could see sterling benefit from safe-haven flows in the near term.
With Spain’s 10-year government bond yields having hit euro-era highs this week, fanning speculation Madrid may need a full-blown bailout, market players expected the euro’s gains to be limited.
Given the level of Spanish long-term yields, Italy put forward a proposal at a G20 summit on Tuesday for the euro zone’s rescue funds to start buying the debt of distressed European countries.
The proposal is expected to be discussed at a meeting of European leaders on Friday but it would require a huge shift in Germany’s stance for it to gather credence.
The euro could see a bounce if the proposal is implemented although a sustained rise is unlikely, traders said.
The euro was flat against the safe-haven yen, to 100.15 yen, while the dollar was barely changed against the Japanese currency to 78.95 yen.
The Australian dollar rose to a six-week high of US$1.0207 as investors bet more Fed stimulus would boost growth-linked currencies.