The euro traded close to a three-month high against the U.S. dollar on Tuesday ahead of an injection of cheap cash from the European Central Bank that looked set to boost risk appetite and fuel short-term gains in the single currency.

It also advanced against the yen, although it stayed well below a four-month peak hit on Monday. The yen pulled away from a nine-month low against the dollar reached the day before on month-end buying by Japanese exporters, but short-covering by hedge funds saw it relinquish some of those gains.

Currency investors shrugged off news that Standard & Poor's had cut its ratings on Greece to selective default as moves by Athens to lighten its debt burden had been expected to trigger such a downgrade.

The euro also showed little reaction to the ECB's temporary suspension of Greek bonds as collateral for its funding operations, and a solid Italian debt auction.

Still, many were cautious about pushing the euro too much higher ahead of an ISDA ruling on Wednesday. The derivatives body will rule whether a credit event triggering a payout on Greek debt insured via the credit default swaps market has taken place after the country began a bond swap.

The euro rose 0.4 percent on the day to $1.3454, trading not far from a near three-month peak of $1.3487 set on Friday. Traders cited decent offers at $1.3480 and a reported option barrier at $1.3500 which would check gains. Immediate support was seen in the $1.3357-66 area around recent lows.

A Reuters poll showed banks will take up half a trillion euros of ECB funds, roughly the same as last time. This would be seen as buying more time for authorities to resolve the sovereign debt crisis.

The impact on sovereign debt spreads would be favorable with a bigger than expected figure so I would expect to see the euro spike a bit higher, said Derek Halpenny, European head of currency research at Bank of Tokyo-Mitsubishi.

We don't expect a breach of the 200-day moving average around $1.3735, although we could get into the $1.36s.

Halpenny said he expected any rally in the euro to be short-lived. Longer-term prospects for the euro were clouded given chances of further rating downgrades and worries that peripheral countries will struggle to meet fiscal targets as tough austerity measures hurt growth.

In the derivatives market, euro/dollar overnight implied volatilities were trading around 14.5 percent. Olivier Korber, option strategist at Societe Generale, said this translated into a daily move of 0.7-0.8 percent either way, which meant traders were not expecting a sharp move in the spot rate.

YEN CHOPPY

In contrast to the euro zone, U.S. economic activity was showing signs of a more sustained recovery, pushing yields higher and driving the dollar up against the Japanese yen, although momentum in that move was flagging.

U.S. durable goods data, due at 1330 GMT, is forecast to fall from the previous month, which could undermine risk sentiment. Any positive surprise could give the dollar some support against the yen.

Also weighing on the yen and putting it on course for its sharpest monthly drop in two years was a record trade deficit, shrinking current account surplus and surprise policy easing by the Bank of Japan.

The dollar was down 0.1 percent at 80.45 yen, having hit a nine-month high of 81.66 yen the day before. It briefly fell as low as 80.01 yen, but managed to bounce back on dollar-buying by Japanese investors unwinding their currency hedges.

Any retracement that we see in the dollar will be a good opportunity to position for more yen weakness, said Stuart Frost, head of Absolute Returns and Currency at fund managers RWC Capital Partners. We are positioning for the dollar to rise to 85 yen in the next three months.

Short-covering by leveraged accounts and yen selling by Japanese importers pushed the euro up to 108.21 yen, 0.2 pct higher compared to late New York levels, but well off the four-month peak of 109.95 yen hit on Monday.