The euro was subdued against the dollar on Thursday on profit-taking after a huge injection of cash by the European Central Bank, with further losses likely due to lingering concerns about debt and a fragile euro zone economy.
The dollar was also supported after U.S. Federal Reserve Chairman Ben Bernanke on Wednesday gave no signal the central bank would undertake further bond purchases. He is due to address the Senate Banking Committee on Thursday.
The euro was slightly lower at $1.3310, having hit a one-week low of $1.3305 in early trade, with near term support at its 100-day moving average of $1.3293. Traders said a fall below that level could push it towards $1.32.
That would be a far cry from a near three-month high of $1.3486 hit on Wednesday. The common currency also posted its best monthly performance in February since October, leaving it ripe for some downward correction.
Traders said there was no immediate euro reaction to the ISDA ruling that no credit event has occurred for Greece.
Attention on Thursday turned to a European Union summit and a meeting of euro zone finance ministers to discuss Greece's progress on meeting the terms of its bailout. Analysts said this may highlight the risks of Greece struggling to comply with the harsh austerity measures demanded of it.
Traders reported early euro selling by Asian central banks and macro funds, with many cutting euro positions as the ECB's injection of 530 billion euros in three-year funds had been broadly priced in.
Any rebound feels like it will be sold into unless there is a sustained improvement in euro zone fundamentals, said Valentin Marinov, currency strategist at Citi.
The LTRO (ECB long-term refinancing operation) brings us back to the situation earlier this year when the euro was considered the (carry) funding currency of choice.
Traders said the $1.35 level could now act as stiff resistance if the euro moves higher, with many investors looking to sell into any rally.
Options traders reported growing demand to buy protection against the euro turning lower against the dollar, suggesting that many expect it to consolidate its recent gains. Risk reversals showed an increase in the premium charged to buy euro puts (bets on it falling) versus the dollar.
Any euro falls are likely to be tempered by factors such as oil exporters converting their dollar revenues into euros and by the fact that market participants remain very short of euros, leaving room for short-covering rallies, Citi's Marinov said.
Morgan Stanley analysts were more upbeat on the euro's immediate prospects, raising their end-March euro/dollar forecast to $1.34 from $1.27 as the ECB's funds eased banking and sovereign debt strains. They still expect the euro to decline sharply by the end of the year, though now see it at $1.19 rather than $1.15.
Investors were mindful that the euro zone's structural debt problems could not be solved unless the economy picks up.
PMI data on Thursday showed the euro zone's manufacturing sector contracted for the seventh straight month in February. In Greece, it shrank at its fastest rate in at least 13 years.
The dollar rose 0.1 percent to 78.752 on a basket of currencies .DXY, off a three-month low of 78.095 hit on Wednesday. It recovered after Bernanke's testimony, although he gave a tempered view of the U.S. recovery.
But RBC analyst Adam Cole said more monetary easing from the U.S. was still possible and the market may have overreacted to the lack of any reference by Bernanke to more QE. This could help a modest recovery in risky assets.
The market is likely to price out the good news from the Fed, he said, adding the euro could squeeze up to around $1.35.
U.S. data of late has surprised on the upside but unemployment remains sticky, keeping alive some expectations of more easing.
The dollar was down 0.2 percent against the yen at 81.06 yen, hurt by profit-taking. However, it stayed close to a nine-month high of 81.661 yen hit on Monday as the yen remains under pressure after Bank of Japan easing measures.
UBS strategists said that they expected the Fed to normalize rates much earlier than the Bank of Japan, a policy divergence that should lead to a widening of two-year Treasuries and Japanese government bond yield gap.
The yield gap has a tight correlation with the dollar/yen pair and a widening should see the dollar drift higher. As such, UBS expects dollar to rise to 85 yen by 2012 and 90 yen by 2013 and repatriation flows ahead of the Japanese financial year end in March is unlikely to yen supportive.
The Australian dollar rose 0.25 percent to $1.0759, helped by robust Chinese PMI data, though it was well below a seven-month peak of $1.0857 hit on Wednesday.