The euro rose against the dollar on Thursday, pulling away from a one-month low on signs Italy's political deadlock may be easing and after it paid less than feared to issue short-term debt, though the single currency remained vulnerable. Markets gained some relief as Italy moved closer to a national unity government, while former European Central Bank vice-president Lucas Papademos was poised to head a new crisis coalition in Greece.
The euro was up 0.5 percent at $1.3616, having earlier hit a one-month low of $1.3484 on EBS in a volatile session. On Wednesday, it lost more than 2 percent, dropping by its most in 15 months against the dollar. Tensions in the eurozone and worries it might eventually break up left the single currency vulnerable to a further move lower, analysts said.
Traders cited talk of large expiries at $1.3500 and $1.3600, which could sway trade. Support for the currency was seen at $1.3405 - the 76.4 percent retracement of the euro's move from a low of $1.3144 on October 4 to a high of around $1.4247 on October 27. Investors were worried that if Italian yields follow the examples of Greece, Portugal and Ireland and keep widening over their German counterparts, Rome could be forced to seek external funding.
However, analysts said there were likely to be bouts of short-covering lifting the single currency as investors take profit on short euro positions. This will mean the euro will not move lower in a straight line, with any recovery likely to be sold into. On the options market, one-month implied volatility - a gauge of market expectations of the euro's moves versus the dollar - surged to a one-month high around 16.50 percent from a low of 14.00 percent the previous session.
One-month risk reversals in euro/dollar - a gauge of the premium demanded to buy bets on a currency falling or rising - rose to record high levels around 4.15 vols in favour of euro puts, or bets on it falling. Italy earlier sold 5 billion euros of 12-month Treasury bills at a lower-than-feared 6.09 percent, while Italian/German government bond yield spreads stabilised as traders said the ECB was buying the country's short term debt, but worries about the country's funding position dominated..
Against the yen, the euro was up 0.2 percent at 105.62 yen, off a two-week low of 104.739 yen and still some distance away from the decade low of 100.77 yen hit in early October. Sterling was up 0.2 percent on the day at $1.5949 after the Bank of England kept rates on hold at a record low 0.5 percent and left its asset purchase targets unchanged, as expected.