The euro hit a near four-month highs against the dollar on Tuesday on expectations a German court will back the euro zone bailout fund and speculation the US Federal Reserve will ease monetary policy further. Gains were seen likely to be capped by the outside risk Germany's constitutional court could still surprise investors by rejecting the European Stability Mechanism in a ruling on Wednesday.
Such a decision would threaten European Central Bank plans to lower the borrowing costs of Spain and Italy - plans that helped lift the euro last week. The euro hit $1.28197, its highest since May 22, but faced tough resistance at the 200-day moving average around $1.2834. It was last trading at $1.2790, still 0.2 percent higher on the day, having rallied more than 6 percent from its two-year low of $1.2042 struck in late July.
It rose on Tuesday after the German court said it would not postpone Wednesday's long-awaited decision despite a new challenge by a eurosceptic lawmaker. "There's been a burst of optimism on the announcement the ruling will not be delayed, but this move looks a bit extreme on the basis it's just confirmation it will be delivered on time," said Michael Sneyd, FX strategist at BNP Paribas. The Netherlands holds an election on Wednesday and a two-day US Federal Reserve meeting ends on Thursday.
Analysts said sentiment toward the euro was broadly positive but the currency was vulnerable to developments in Spain, which is expected to ask for a bailout, and in Greece, whose foreign lenders rejected parts of a government austerity package. The dollar index fell to a four-month low of 80.122, while the dollar slipped to a three-month trough against the Swiss franc of 0.94154 francs.
The dollar fell to a six-week low of 77.96 yen, down 0.3 percent on the day, falling past a reported option barrier at 78 yen with stop-loss orders cited at 77.90 yen by traders. "There will be a lot of support for the dollar at lower levels as the Japanese will not like the yen to appreciate much from here," said Stuart Frost, head of absolute returns and currency at fund managers RWC Capital.
Analysts said the Japanese authorities were likely to step up threats to intervene in the currency market and the Bank of Japan could ease policy further when it meets next week to offset any impact from possible easing by the Fed. The growth-linked Canadian dollar rose to a one-year higher against the US dollar, buoyed in part by the Bank of Canada's tightening bias.
The dollar fell to C$0.9723. Some say the dollar could drop to C$0.9652, the 76.4 retracement of its move from a 2011 low of $0.9407 to this year's high of C$1.0445. The Canadian dollar has also outperformed the Australian and New Zealand dollars in the past few sessions.
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