The euro rallied from a two-year low against the dollar on Friday, bolstered by a rebound in equities and commodities after China's economic data came in less dire than feared, although the currency's outlook remained bleak due to the region's persistent debt uncertainty.
The euro zone common currency survived a surprise cut in Italy's credit ratings by Moody's, which highlighted the risk that the debt crisis could potentially engulf the bloc's third-largest economy.
Sentiment was buoyed, however, by data showing China's economy grew 7.6 percent in the second quarter, the weakest pace in more than three years but still better than some outlooks.
"The euro finally caught up with the risk rally that prompted short-covering given that it had been sold off sharply in recent sessions," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington.
"Investors still have a fairly sceptical outlook for the euro and its overall bearish tone leaves it vulnerable to a sell on rallies," he said.
The euro last traded at $1.2235 against the dollar, up 0.3 percent, its biggest one-day rise in two weeks. It earlier fell as low as $1.2160, its weakest since mid-2010. The slide in the euro came in the wake of Moody's Investors Service's downgrade of Italy's sovereign debt rating to Baa2, citing doubts over the country's long-term resolve to push through much-needed reforms.
On the week, the euro was down 0.2 percent and off more than 5 percent so far this year - far exceeding 2011's annual loss of 3.2 percent. Declines accelerated after last week's deposit and refinancing rate cuts by the European Central Bank.
"For the most part, it's Friday, the market is thin and everybody is short," said Ronald Simpson, managing director of global currency analysis at Action Economics in Tampa, Florida.
"Euro/dollar has made new daily lows nine days in a row now," he said. "I think it's just a bit of a short squeeze, driven by various rumours and talk."
Next week, the focus would shift to Federal Reserve Chairman Ben Bernanke's semi-annual testimony to the US Congress on the economy.
Analysts at Barclays Capital expect him to reiterate that the Fed would take further easing measures only if necessary but give no indication any such action is imminent.
Investors hoping for more concrete plans about further stimulus to the US economy may be disappointed and Bernanke's view could well support the dollar next week.
Currency speculators have once again increased their bets in favour of the greenback, with the value of the dollar's net long position rising to $24.58 billion in the latest week.
Despite the euro's gains on Friday, analysts at ActionForex.com said there is no sign of a bottom yet. Intraday bias remains on the downside, they said, for a test of minor support at $1.2132. A break of that will target $1.1875, the low hit in early June 2010.
On the upside, a break of minor resistance at $1.2333 is needed to signal short-term bottoming, ActionForex said. Otherwise, the outlook remains bearish.
TD Securities analysts also said the technical charts suggested a further fall in the euro to the mid-$1.15 area and gains are likely to remain limited to the $1.23 to $1.24 range at most.
With the euro's gains, implied volatility, a measure of a currency's price movements in either direction, dropped to below 10 percent, its lowest in more than a week, suggesting less anxiety in the near term.
The euro also rose against the yen, trading 0.3 percent higher at 96.98 yen, although it was down 0.8 percent this week.
While Moody's warned it could further downgrade Italy's credit rating, now just two notches above junk status, if the country's access to debt markets were to dry up, Italy managed to pass a tough market test as three-year borrowing costs fell well below 5 percent.
Investors also mostly shrugged off data in the United States that showed consumer sentiment cooling in early July to the lowest in seven months.
Separately, US producer prices rose only slightly last month as energy costs dropped, suggesting inflation pressures remain muted and leaving the door open for more easing by the Federal Reserve.
Against the yen, the dollar was flat at 79.25 yen.
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