The euro slipped on Wednesday but was holding not far from a seven-week high, with traders saying it could rise further in the near term due to doubts about a recovery in the U.S. economy and positive technical signals.
The euro eased 0.4 percent to $1.2578, after meeting resistance around the May 21 high of $1.2673 and on selling from a hedge fund. It hit $1.2663 on trading platform EBS on Tuesday, the highest in about seven weeks.
Still, one positive factor for the euro was the fact that it finished Tuesday's U.S. trading above resistance at the bottom of the daily Ichimoku cloud -- a signal that its entrenched downtrend may be over.
The euro in mid-December slid beneath the cloud on the Ichimoku chart, the Japanese chart pattern that is closely followed across markets, and had mostly traded below it since then. But its rise back into the cloud suggests the single-currency may have entered a consolidation phase.
The euro is in a retracement phase in the wake of its drop to below $1.2 and could rise back toward the top of the cloud, said Tokichi Ito, deputy general manager for Trust & Custody Services Bank's forex team.
While worries about the euro zone's debt woes linger and market players refrain from actively taking long positions in the euro, Ito said the euro may see a short-covering bounce toward $1.2800, near the top of the daily Ichimoku cloud.
The euro was also supported after a strong response to a syndicated Spanish debt sale. The robust demand eased some of the worries about the debt problems in the euro zone, although traders said they would remain cautious until the stress test results of the euro zone's banks are out later this month.
What we are seeing is some position adjustment which is driving the euro, said Tony Morriss, senior currency strategist at ANZ. The common theme that is gaining ground in currency markets is the U.S. dollar is being weighed down by soft U.S. economic numbers.
A Financial Times column headlined The ECB may yet turn to quantitative easing was also a talking point in the market, mildly pressuring the euro.
Traders said that the world's other major central banks may also need to ease policies further in the event of a U.S. double-dip and that the implications for currencies were far from clear.
The dollar index edged up 0.2 percent to 84.235, staying near a two-month low of 83.825 hit this week. The dollar index lost ground on Tuesday after a lackluster report on business activity in the U.S. service sector.
The dollar held steady against the yen at 87.49 yen, not far from a seven-month low of 86.96 yen hit on EBS last week.
The yen has made solid gains against the greenback in recent sessions on the back of growing worries about an economic slowdown in the United States and falling stock markets.
Those concerns got a boost from a disappointing jobs report from the U.S. late last week. That followed a raft of weak reports which suggested consumer spending, housing and factory activity were moderating.
I think what we will see for a while is dollar selling, coupled with bouts of backing off from risk-taking when there are any sharp falls in equities, said Akira Hoshino, chief manager for Bank of Tokyo-Mitsubishi UFJ's foreign exchange trading department.
The yen is one currency that may benefit in this market environment, Hoshino said.
Market players said the yen took in stride a Kyodo news agency poll showing that Japan's ruling Democratic Party could win fewer than 50 seats in an upper house election on Sunday, a result that could put Prime Minister Naoto Kan's job on the line and stall efforts to curb huge public debt.
It is hard for the market to show a definite reaction, said Osamu Takashima, chief fx strategist Japan for Citibank Japan.
While a political crisis for the ruling party could be regarded as a negative for a country's currency, any such impact in this case could be offset by the fact that market players regard Kan as someone who favors a weaker yen, he said.
The Australian dollar, which has had a strong correlation with Asian shares and the market's risk appetite in general, dipped 0.5 percent to $0.8480, giving back some of its 1.5 percent climb the previous day, as Asian share prices fell.
The Australian dollar rose and appetite for risk got a boost in the previous session after the Reserve Bank of Australia gave an upbeat assessment of the economic outlook for Asia and the domestic economy.
(Additional reporting by Anirban Nag in Sydney and Hideyuki Sano in Tokyo; Editing by Joseph Radford)