The euro paused below a 12-week peak on Thursday, though hawkish comments from the European Central Bank later in the day could give it fresh impetus to test resistance around $1.3950. The euro could gain even more if Federal Reserve Chairman Ben Bernanke, who is due to speak only a few hours after ECB chief Jean-Claude Trichet, reaffirms the bank's policy is still focusing on boosting growth.
The euro traded at $1.3798, having slipped on profit-taking after it marked a 12-week high of $1.3862 on Wednesday, though it is more than 7 percent above a four-month trough of $1.2860 hit less than a month ago. The euro moved little in Asia on Thursday, with many Asian players away for the Lunar New Year holidays and as traders looked to Trichet's news conference at 1330 GMT. Similar risk also exists for the speech from the Fed chief, due at 1730 GMT, if he turns out to be less dovish than many market players have hoped.
That should keep eurozone interest rates much higher than dollar rates, and help the euro test resistance around $1.3950, where it has a 76.4 percent retracement of its two-month decline to early January as well as its 200-week moving average. In addition, worries on the eurozone's debt problems are falling off many market players' radars as yields on Spanish and Italian government bonds fell sharply to two-month lows. Although the euro dipped slightly on news that supporters of Egyptian President Hosni Mubarak opened fire on protesters in Cairo, the impact was limited.
Expectations of a credit tightening are also helping the British pound stay close to a three-month high. Sterling stood at $1.6194, not far from Wednesday's three-month peak of $1.6232. While interest rate differentials are seen playing a big role in currency transactions, one currency pair that has seen a breakdown in correlation with yields is the dollar/yen. The yield on US two-year notes, which had strong correlation with dollar/yen moves last year, has almost completely lost its link to dollar/yen in the past month.
The US two-year bond yield rose to its highest in nearly a month on Wednesday but that had a limited impact in boosting the dollar versus the yen and the one-month correlation of the two assets is now close to zero. The Aussie rose 0.1 percent to $1.0103, inching closer to a one-month peak of $1.0149 marked earlier in the week as it drew support from strong Australian trade data. But the New Zealand dollar dropped sharply after a surprise jump in unemployment.
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