German Chancellor Angela Merkel's conservatives and the SPD on Wednesday agreed to a coalition deal, taking the country closer to a new government after months of uncertainty that have unnerved allies and investors and investors alike.

But although reports suggest that the SPD is likely to take the finance ministry, some investors were disappointed that the current mayor of Hamburg, Olaf Scholz, was slated to head up the ministry, and not Schulz.

"There was speculation that Mr Schulz could be the next finance minister," said DZ Bank currency strategist Soeren Hettler, in Frankfurt. "(In that scenario), Germany could be more flexible with regard to its financial situation and spend more money."

"Now we have some uncertainty and have to wait until things are clear," he added. "For the euro, this is the most important thing ... The finance minister is the second-most important for the government."

The euro, which had been trading higher on the day before the news, lost around 0.4 percent to trade at $1.2334.

The dollar slipped back against the yen, handing back earlier gains, as investors remained cautious despite a recovery in stock markets, with many viewing the Japanese currency as undervalued.

PROSPECT OF TIGHTENING

A sharp decline in global share markets in recent days has had only a muted effect on the currency market, with traditional safe havens such as the yen and Swiss franc seeing only modest gains.

While most analysts believe this week's heavy selloff across stock markets has run its course for the moment, allowing volatility to abate a little, the prospect of monetary tightening across the globe remains a challenge for the long term, and supported the yen against the US currency.

The dollar traded as low as 108.92 yen before edging up to trade at 109.22 yen by 1220 GMT.

The greenback had reached a high of 109.720 yen earlier in the day as regional equities such as Japan's Nikkei soared, taking their cue from a late rebound on Wall Street.

But it drifted lower as the Nikkei, which rose as much as 3.4 percent, gave back most of its gains on anxiety over more weakness in US share markets as US stock futures fell during Asian trade.

"Everybody in the world can see dollar/yen is going to break lower at some point again and that the yen is going to make a move (higher) like the euro did and head back towards fair value, 30 seconds after the Bank of Japan even hints about tapering," said Societe Generale macro strategist Kit Juckes, in London.

The dollar was up 0.4 percent against a basket of six major currencies at 89.61, after reaching a two-week peak of 90.034 the previous day.

The Swiss franc, a perceived safe haven along with the yen, was down half a percent against the dollar.