LONDON: The euro edged higher on Thursday against a weaker dollar but gains were capped by the possibility that the European Central Bank could flag more policy easing if it deemed economic recovery and inflation are at risk from currency appreciation.
Most other currencies too ground higher as the dollar resumed its downtrend following a US technology shares bounce that suggested improving risk appetite. The greenback had hit a one-month high against a currency basket on fears world markets were headed for another downturn.
Attention, however, centered on the euro and the ECB's governing council meeting later on Thursday. The bank is all but certain to keep policy unchanged but President Christine Lagarde's comments on the euro's recent rise to two-year highs will be closely monitored.
It has risen almost 6% against the dollar from June lows, while euro area consumer prices turned lower in August for the first time since 2016.
Lagarde may also comment on future inflation strategy after the US Federal Reserve's policy switch that implied keeping interest rates lower for longer.
"The backdrop is a challenging one, with weakness in the (inflation) numbers and we are coming into the meeting with a stronger euro. The message is likely to be dovish but the challenge is: what can they actually do?" said Justin Onuekwusi, a portfolio manager at Legal & General.
Onuekwusi noted the ECB's emergency bond-buying scheme was running well below the $1.35 trillion ceiling, meaning the bank can merely flag increasing purchases at some point in future.
"The risk is the message won't be dovish enough," he added.
The euro bought $1.1829, up 0.2% on day. It had received a boost on Wednesday after Bloomberg News reported that ECB officials are growing more confident in the bloc's economic outlook.
Many reckon also the ECB will struggle to tamp down euro strength, given greater investor confidence in the bloc after the creation of a joint recovery fund and a robust response to the pandemic.
Moreover, euro interbank rates have hit record lows this week, showing financial system liquidity remains abundant.
Petr Krpata at ING Bank said the Bloomberg report suggested the ECB sees less need for imminent action, and predicted Lagarde would restrict herself to saying the exchange rate was being closely monitored.
"All this suggests a modest upside risk to euro/dollar with the pair moving to or above the 1.1850 level today," he said.
Elsewhere, dollar weakness - the index slipped 0.2% on the day - allowed sterling to stabilise above $1.30. It dipped to a six-week low of $1.2839 on Wednesday after Britain unveiled draft legislation which raises risks of it exiting the EU single market with no trade agreements in place.
The pound slipped to 90.9 pence per euro however, close to a six-week low.
The Australian dollar fell to $0.7263 amid concerns abound worsening diplomatic ties with China over the treatment of the two countries' journalists. Investors are also monitoring an outbreak of coronavirus infections in the state of Victoria.