The euro and Australian dollar hit their highest against the U.S. dollar in about a month on Monday after China allowed the yuan to rise to a post-revaluation high, boosting demand for riskier currencies.
The single European currency extended its recovery versus its U.S. counterpart, pulling further away from its weakest in more than four years hit earlier in the month, but confidence in the euro's recovery remained fragile.
Spot yuan rose to its highest since its 2005 revaluation on the view that a freer currency will be positive for the global economic recovery, and spurred a rise in commodity and oil prices and boosted riskier assets.
It also added to hopes of easing tensions in the Group of 20 leading economies ahead of a meeting later this week.
The market's reaction has been pragmatic, both in terms of scale and direction, said Daragh Maher, senior currency strategist at Credit Agricole CIB, noting that the euro's gains had been subdued compared with the Australian dollar's rally.
The bullish risk view supports the argument to sell the dollar, but there are better ways to play it rather than buying the euro. It makes more sense for Asian currencies and the Aussie and kiwi to rise.
He added that China would be cautious about the pace of a yuan appreciation, and in a note, Credit Agricole said that given the euro's 13 percent fall versus the yuan this year, Beijing may be wary of accelerating the currency's rise for fear it could limit Chinese trade with Europe.
The dollar slipped versus a basket of currencies .DXY to a one-month low of 85.091 as the euro rose to $1.2490 on trading platform EBS, its highest level since May 24.
By 1106 GMT, the euro had pared gains to $1.2390. Traders said option barriers at $1.2500 were preventing further gains, reportedly being protected by a major Asian sovereign account.
The euro posted its best weekly gain versus the dollar since May 2009 as investors trimmed bets against the single currency, buts its recovery remains fragile given concerns about the impact of debt problems in some euro zone countries on the global economy.
A sell-the-rally mentality persists for the euro in the short-term. Its rise has been a function of position adjustment. said Paul Mackel, director of FX strategy at HSBC.
Mackel suggested brighter signals were needed in euro zone bond markets for the currency's recovery to be sustainable.
The higher-yielding Australian dollar gained 1.4 percent to around $0.8840 after hitting $0.8860 as European equities .FTEU3 rallied 1.3 percent.
Markets have been worried China could over-tighten and slow its economy too far, which had raised concerns about Beijing's demand for natural resources, which would impact commodity-linked currencies including the Australian dollar.
But the strong yuan helped to boost the Australian dollar across the board, lifting it 2.5 percent against the yen to hit a one-month high of 80.80 yen.
The low-yielding yen suffered broadly, pushing the euro 0.9 percent higher to 113.30 yen, while the dollar rose 0.9 percent to 91.45 yen.
(Additional reporting by Neal Armstrong, editing by Toby Chopra)