The euro rose against the dollar on Wednesday on revived hopes that European leaders will take aggressive steps at a summit this weekend to resolve the region's debt crisis.
Although officials dismissed a story in Britain's Guardian newspaper that France and Germany had agreed to a deal boosting the European Financial Stability Facility (EFSF), investors still latched onto the report as a reason to pare back bets against the euro.
Optimism that a definitive plan would be in place by this EU summit on Sunday had sparked a rally in the euro last week. Germany later tamped down enthusiasm by saying the summit would not provide an ultimate solution to the debt crisis.
It seems the pendulum is swinging again toward a more optimistic take on that meeting and the expansion of the EFSF, said Vassili Serebriakov, senior currency strategist at Wells Fargo in New York.
The euro was last up 0.4 percent at $1.3796. It earlier rose as high as $1.3870 on trading platform EBS, approaching the one-month high of $1.39148 set on Monday.
The Guardian, citing senior European Union diplomats, said the euro zone would endorse a five-fold increase in the 440 billion euro bailout fund, giving it some 2 trillion euros to help troubled governments and banks survive should Greece or any other euro zone country default.
But a senior euro zone source told Reuters there had been no mention of such a deal. A spokesman for the German Finance Ministry said the bailout fund will not be raised beyond the 440 billion euros already approved nor will Germany's participation rise beyond 211 billion euros.
The market is giving European politicians the benefit of the doubt; it is hard to believe they will not do something significant at the summit, said Steven Saywell, head of FX strategy at BNP Paribas in London.
Chris Turner, FX strategist at ING, said demand to cover short positions in the euro remained high given that the average entry level of such positions in September was around $1.37. The euro's rally above $1.39 earlier this week put investors at risk of a loss on those positions.
Going into the summit, Turner said, the euro may rally toward $1.40 if more mainstream press reports suggest EU leaders are nearing agreement to take decisive actions.
The euro briefly extended gains against the dollar after data showing U.S. housing starts in September topped expectations boosted the appetite for risk.
Sovereign demand from the Middle East and Asia likely also boosted the euro, traders said, although some doubted it was the dominant driver behind gains.
Adam Myers, currency strategist at Credit Agricole CIB, said Asian central banks, which continue to buy dollars to weaken their own currencies, were plowing those proceeds into other assets, including euro-denominated assets.
While people are talking about fundamental and policy-related reasons for euro resilience, I think the more likely reason is that there's been a transferal of Asia's holdings of U.S. assets into European ones, Myers said.
Led by those in Asia and Russia, central banks were net sellers of U.S. Treasury holdings in August to the tune of $9.6 billion, the biggest net outflow since May of 2009, according to the U.S. Treasury Department.
Against the yen, the euro rose 0.4 percent to 105.90 yen. It gained 0.6 percent against the Swiss franc to 1.2429 francs, having hit 1.2475 on EBS, the highest level in five months on persistent, though unconfirmed, market talk of the Swiss National Bank raising the euro/Swiss target rate from 1.20 francs.
Investors shrugged off a double-notch downgrade of Spain's debt rating.
The dollar index was last down 0.3 percent at 76.874, while the greenback was flat against the yen, at 76.77 yen, trapped between bids around 76.65 and offers at 76.85 yen.