A sharp fall in Spanish short-term borrowing costs boosted the euro on Tuesday albeit in thin trade, with fresh signs that the German economy is holding up in the teeth of the euro zone debt storm also supportive.
But sentiment was fragile and investors were still looking to sell into a bounce as efforts by policymakers to address the debt crisis fell short of expectations and European Central Bank chief Mario Draghi dashed hopes of any aggressive support.
The euro was up 0.6 percent at $1.3075, above an 11-month low of $1.2944 hit last week and a Monday session trough of $1.2983. It extended gains to hit a session high of $1.3085 after the German Ifo survey with stops above $1.3060 triggered after Spain issued short term debt at sharply lower costs.
The Munich-based Ifo think tank said its business climate index, based on a monthly survey of some 7,000 companies, rose to 107.2 in December from 106.6 in November, confounding expectations of a fall..
Raghav Subbarao, a currency strategist at Barcap said that while German data, including the Ifo survey, was showing signs of holding up, the overall outlook was that of pessimism.
"German data is holding up and that increases the probability of a hawkish ECB, but that is not necessarily good for the overall real economy," he said.
"We have significantly revised down out forecasts for the euro and now expect it to drop to $1.20 in a year's time, down from $1.35 previously forecast. That is mainly because we are expecting a more dovish ECB....that would take away one of the major factors that has been supporting the euro earlier this year."
Still, with most currency speculators already bearish against the euro, there is a chance that the euro could receive a brief lift on unwinding those positions ahead of the year-end.
Another factor that was supporting the euro was expectations that banks will borrow a large amount of three-year funds from the ECB later this week and invest some of the money on buying peripheral debt and use them as collateral. Euro zone banks are expected to buy some 250 billion euros, according to a Reuters poll.
Italian 10-year government bond yields were last 13 basis points lower at 6.74 percent, narrowing the spread over Bunds to 481 bps. Equivalent Spanish paper fell 8 bps to 5.18 percent.
Despite the narrowing of yields, sentiment towards the euro zone was bearish. European leaders are still falling short of market expectations to come up with measures to contain the region's debt crisis two weeks after a key EU summit failed to come up with a comprehensive solution.
ECB Draghi told European Parliament on Monday that the ECB's purchases of peripheral debt were temporary and "not infinite", disappointing investors who were hoping for further bond buying that would keep yields stable.
European policymakers also failed on Monday to boost resources at the International Monetary Fund by an expected €200bn. Instead they agreed to bolster lending by €150bn ($195bn), casting fresh doubts on whether the scheme would work to save larger economies like Italy.
"They have agreed to boosting resources by €150bn which still raises questions about Italy and the threat of rating agencies looming," said Simon Derrick, head of currency strategy at Bank of New York Mellon. "You just need another piece of bad news and the euro will nudging closer to its 2011 lows."
The common currency's 2011 lows of around $1.2860 were struck in early January and analysts say the failure to persuade countries to bolster lending to the IMF participate will be negative for the euro.
Indeed, Morgan Stanley strategist said they were looking to sell euro/dollar on rallies to $1.31 as they expect risk appetite to remain subdued heading into the year end and as such that will support the U.S. dollar.
The euro rose briefly to a session high of 9.0150 against the Swedish crown after Sweden's central bank cut the repo rate, before giving up those gains to trade at 8.9695 crowns. The decision was a close call after Norway's central bank lowered rates by 50 basis points last week, matching a recent easing by the ECB.