Euro slips on doubts over effective ECB response

The euro earlier hit a one-month high against the dollar, adding to Friday's gains on investor optimism the European Central Bank would step in and buy bonds to reduce high Spanish and Italian borrowing costs in coming months.

But analysts said uncertainties remained over the ECB's plan and many saw more pain for the euro zone before a resolution to the crisis was reached. This meant some investors were inclined to use the euro's bounce to put on fresh bets the currency would weaken.

"There hasn't been anything that has improved the situation in Europe ... we haven't had any concrete improvement in the situation in the euro zone," said Niels Christensen, currency strategist at Nordea in Copenhagen.

"The move higher was more closing of short euro positions than actually putting on new long positions because people were expecting a higher euro ... I can only expect that people are still looking for the downside in euro/dollar."

The euro was down 0.3 percent at $1.2355, below a peak of $1.2444 hit in Asian trade, its strongest since July 5. Near term resistance was seen at around $1.2478, the 61.8 percent retracement of its drop from a mid-June peak to a two-year low of $1.2042 struck in late July.

ECB President Mario Draghi said last week the bank would act only in cooperation with the euro zone bailout funds, and would require countries to ask for help first. Spanish Prime Minister Mariano Rajoy has signaled he may seek a full-blown aid package but is still undecided.

The euro's losses lifted the dollar against a basket of currencies. The dollar index was up 0.2 percent at 82.48 .DXY.

The dollar eased 0.2 percent to 78.30 yen but held above a two-month low hit last week. The euro was down 0.5 percent at 96.70 yen, having earlier risen to 97.80, its strongest since mid-July.

CHOPPY TRADING

The euro has seen choppy trading since the ECB's policy meeting last Thursday.

While some are relieved the central bank is prepared to act by buying bonds in the secondary market and expanding its balance sheet, many are not convinced this alone will be sufficient to trigger a sustained euro rally.

However, analysts at Morgan Stanley recommend buying the euro at 96.70 yen, with a target of 105.00 yen and a stop at 95.20.

"The ball is now in the politicians' court, and we believe it is only a matter of time before they choose, or are forced by markets, to ask for official aid, opening the door for ECB purchases and a tightening of peripheral spreads," they said in a note to clients.

Traders said a narrowing in peripheral bond yield spread over Germany was likely to offer some support to the euro in the near term. Besides, hefty speculative bets against the euro meant that the common currency could gain some ground due to unwinding of those positions, before falling afresh.

"We remain skeptical of the euro's gains and think any bounce into the $1.25-1.26 area will be a good level to initiate short positions again," said Peter Kinsella, currency strategist at Commerzbank.

"What President Draghi has indicated is he will do everything to protect the euro and to us that means the ECB balance sheet will be expanded. We expect the euro to gradually depreciate, something which will help the peripheral countries."