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Wed 7 Dec 2011 11:34 AM

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Euro claws higher, stays above one-week low

Markets optimistic European leaders will take decisive action to contain region's crisis

Euro claws higher, stays above one-week low
Disappointing results of EU summit could drag the euro down to levels near $1.3215

The euro clawed higher on Wednesday and stayed above a one-week low hit the previous day, with markets cautiously optimistic that European leaders will take decisive action to contain the region's debt crisis at a summit later this week.

The euro rose 0.3 percent to $1.3435, hovering above Tuesday's low near $1.3334. There was talk of light stop-loss bids in the euro at $1.3470 and also near $1.3500.

Still, the limited scope of the euro's bounce suggests that market players remain cautious about its outlook, said Mitul Kotecha, head of global foreign exchange strategy for Credit Agricole in Hong Kong.

"Although it's supported against the backdrop of pretty strong expectations, I think there is certainly still some hesitation to be too optimistic given the disappointments we've had in the past," Kotecha said, referring to market expectations for a European Union summit on Friday.

A focal point is whether euro zone leaders make enough progress toward fiscal integration and more stringent fiscal discipline to open the way for the European Central Bank to take a greater role in stabilising euro zone bond markets.

Investors are also focusing on possible initiatives to increase the capabilities of rescue funds that could help backstop euro zone governments hit by debt market turmoil.

Euro zone officials have said euro zone leaders may decide on Friday to raise the combined lending limit of their temporary and permanent bailout funds to boost the firewall they hope will contain spread of the sovereign debt crisis.

Even if significant progress on such issues is made at the summit, doubts about their implementation could limit any gains in the euro, said Credit Agricole's Kotecha.

"There's still a lot of questions to be asked... If we do see this two-tier bailout fund, where is that money coming from?" he said, adding that any rally in the euro may be limited to levels around $1.3550 in the short term.

Disappointing results could drag the euro down to levels near $1.3215, with a clear breach of that support opening the way for a drop to the $1.3140/50 area, he added.

Another key event this week is the European Central Bank's policy decision on Thursday.

The ECB is likely to cut interest rates by 25 basis points to 1.0 percent.

The central bank is also seen likely to offer ultra-long liquidity operations to support banks, while leaving the door open to further measures to fight Europe's debt crisis if governments agree on fiscal reforms.

"We see scope for some additional short covering between now and the weekend... One caveat being if the ECB surprises with more aggressive easing on Thursday than the 25-basis-point reduction in the refinancing rate that is generally expected," analysts at BNP Paribas said.

The Swiss franc stayed on the defensive versus the euro after a fall in consumer prices to two-year lows boosted speculation the Swiss central bank will weaken the currency further to shield the economy from the risk of deflation and recession.

The euro rose 0.2 percent against the Swiss franc to 1.2426.

There was talk that hedge funds have been buying euro/Swiss franc call options with a strike price at 1.2500 francs that are due to expire in the next week or two. In addition, traders cited talk of a large euro/Swiss franc option barrier at 1.2500 francs.

The Australian dollar rose 0.3 percent to $1.0277 , holding firm after data showed Australia's economy grew a brisk 1.0 percent in the third quarter from the previous three months.

The dollar held steady versus the yen at 77.73 yen .

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