The euro hovered close to a two-month peak against the dollar on Tuesday, retaining support after last week's European bank stress tests revealed no horrors while increased demand for riskier assets weighed on the dollar.
Although concerns lingered that the stress tests were not tough enough, analysts said these could be calmed when Deutsche Bank discloses its exposure to euro zone sovereign debt.
The dollar fell to a 12-week low against a basket of currencies as recent weak U.S. data accompanied an otherwise brighter outlook for the broader global economy, encouraging investors to move into higher-yielding and riskier assets.
Underscoring this, India hiked interest rates on Tuesday , citing inflationary pressures and a firm economic recovery, while the Reserve Bank of New Zealand is expected to raise rates later this week.
We are seeing a more risk friendly environment, said Peter Frank, currency strategist at Societe Generale.
The market has drifted away from fears of a double dip, and the rate tightening environment -- with a rate hike in India and one expected in New Zealand -- is attracting flows into higher yielding and emerging market assets and out of the dollar.
At 4:07 a.m. ET, the euro was steady at $1.2992, having earlier risen as high as $1.3023. Traders cited Asian central bank bids around $1.2970-80, but said reported offers above $1.3020 on behalf of a European sovereign were capping gains.
The euro headed toward last week's more than two-month peak of $1.3029. If it scales this, its next target will be $1.3125, the 38.2 percent retracement of its December-June fall, technical analysts said.
Falls were also seen limited while it remained above support at $1.2870 -- close to its 100-day moving average -- and last week's low around $1.2730.
Traders were cautious as they awaited clarity on Deutsche Bank's (DBKGn.DE) debt exposure after the German bank posted second-quarter earnings.
However, they said if the bank discloses no shocks, this could help build confidence in euro zone banks and dispel concerns about a lack of transparency in the stress tests, triggering buying in the euro.
Despite all the negative talk about the stress test results, German interest rates are rising and the euro firmed, which seems to suggest lingering euro short-covering needs, said Osamu Takashima, chief FX strategist at Citibank in Tokyo.
The dollar index .DXY was steady at 82.102, having earlier fallen to 81.913, its weakest since early May.
Sterling hit a five-month high of $1.5530 as the UK currency made further gains in the wake of surprisingly strong gross domestic product data on Friday.
Among higher-yielding currencies, the Australian dollar was steady at $0.9023, holding above the key $0.90 level and close to 11-week high of $0.9031 hit on Monday, while the New Zealand dollar touched a six-month high of $0.7355.
Investors' greater appetite for risk also weighed on the low-yielding yen, with the U.S. dollar gaining 0.4 percent to 87.19 yen. The euro rose to a seven-week high against the yen of 113.64 yen, with traders saying gains accelerated after stops were triggered above 113.50 yen.
(Additional reporting by Hideyuki Sano in Tokyo)