The euro edged higher against the dollar on Monday, extending the previous session's gains on hopes the European Central Bank will take action to lower borrowing costs for Spain and Italy. With little news to drive markets, investors continued to focus on comments from ECB President Mario Draghi last week, when he said the bank will draw up plans for bond buying in the coming weeks.
Gains in the equity market sparked by Friday's data showing surprisingly strong US jobs growth in July also boosted the euro, prompting investors to pare hefty bets against the currency. "Investors are less pessimistic about the euro zone situation," said Aroop Chatterjee, senior currency strategist at Barclays Capital in New York. "There is the expectation that something positive will come out of the ECB plan and so investors are more willing to search for risky assets that look attractive."
The euro last traded 0.1 percent higher at $1.2400, below a one-month peak of $1.2443 hit in Asian trade. Gains in the euro over the last two sessions totalled nearly 2 percent, its best two-day showing since late October. Near-term resistance for the euro was seen around $1.2478, the 61.8 percent retracement of its drop from a mid-June peak to a two-year low of $1.2042 touched in late July.
Yet doubts persisted about the ECB's proposed plan of action and many saw more pain for the euro zone before any resolution to the crisis might be reached. This meant some investors were inclined to use the euro's bounce to place fresh bets the currency would weaken.
ECB President Mario Draghi said last week the bank would act only in co-operation with the euro zone bailout funds, and would require countries to first ask for help. Spanish Prime Minister Mariano Rajoy has signalled he may seek a full-blown aid package but is still undecided.
"There is a definite dichotomy in investor sentiment at the moment," said Andrew Cox, currency strategist at CitiFX in New York. "There has been a good bit of interest from shorter-term traders to fade the recent bout of euro strength given the lack of action and follow-through from Draghi last week."
On the other hand, Cox cited ongoing demand for real assets in Europe, both sovereign debt and equities, "which we feel is driven by the dissipation of euro zone tail risk - a development that could continue to support the euro in the coming weeks." The common currency was down 0.2 percent against the yen at 96.99, having earlier risen to 97.79 yen, its strongest since mid-July. The euro was also slightly lower against the Swiss franc and 0.3 percent weaker against the Norwegian crown.
Spanish and Italian bond yields fell on Monday, led by shorter-dated paper. Two-year Spanish yields have more than halved from euro-era peaks above 7 percent hit on July 25 to 3.42 percent. 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 again.
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