The euro on Tuesday clung to nearly all of the previous day's huge gains after hopes for a new EU debt plan sparked a correction in a deeply bearish market, though sentiment remains fragile as European leaders have disappointed many times before.
The euro, which on Monday surged 2 percent for its biggest daily percentage gain in 15 months, dipped 0.1 percent to $1.3629 in early Asia trade.
Monday's rally followed an Franco-German pledge on Sunday that they would do what is necessary to shore up banks, settle the Greek crisis and help growth in Europe.
Market players said the single currency could rise further in the near term given a recent build-up in short euro positions, but added that a sustained rebound was unlikely.
"An image of the euro falling without limit is receding, but unless there is some kind of fundamental solution, a clear break above $1.40 will probably be difficult," said Satoshi Okagawa, senior global markets analyst for Sumitomo Mitsui Banking Corporation in Singapore.
"There could be some short-covering for a while, in the wake of its selloff," Okagawa said.
Data from the US Commodity Futures Trading Commission shows that currency speculators increased their net short positions in the euro to 82,697 contracts in the week ended Oct. 4, the biggest in four months.
A trader for a European bank in Singapore said the euro still looked well bid with bids mainly near $1.3600, although offers were accumulating at levels above $1.3700.
Major resistance for the euro is found at $1.3680-90, the 38.2 percent Fibonacci retracement of the $1.4550/$1.3145 move and the Sept. 28 trend high. A clear break above $1.3700 targets $1.3845.
Dealers were surprised by the scale of the reaction to the Franco-German pledge, given EU leaders have disappointed many times in the past.
"Unfortunately, Europe has a history of delivering far too little far too late," said Robert Rennie, chief currency strategist at Westpac.
"Europe doesn't have the political will, the cohesion and the sense of what needs to be done."
He said the rally was temporary and that he would be looking to sell the euro into strength, which means in the $1.365-$1.385 range.
Investors were looking for an excuse to price out bad news that has gripped markets since September. While there is little doubt the problems in Europe will resurface at some stage, recent economic data was better than feared, reducing the danger of a global recession,
The Australian dollar fell 0.2 percent to $0.9969, giving back a bit of its gains after climbing 2.4 percent on Monday, its biggest one-day rally since June 2010.
The Aussie faces stiff resistance looming at the broken trend line on its weekly charts around $1.0010-30, and also at $1.0035 - a 38.2% retracement of its slide from a $1.1081 high in late July to a $0.9388 trough plumbed in early October.
Traders will focus on voting in Slovakia on Tuesday, the only country among the bloc's 17 members that has yet to ratify changes to the euro zone's 440-billion-euro bailout fund. Any delay on passing the legislation could affect sentiment toward the euro. Malta gave its backing on Monday.
The dollar held steady at 76.66 yen , still not far from a record low of 75.941 yen struck in August on trading platform EBS.
The yen took in its stride comments from Japan's ruling party policy chief Seiji Maehara, who was quoted by Jiji news agency as saying yen-selling intervention was needed to counter an extreme appreciation in the currency.
Dollar/yen has been stuck in a narrow trading band in recent weeks. Wariness about the potential for yen-selling intervention has lent dollar/yen support, but dollar selling interest from Japanese exporters has helped limit its gains.
This week's focus will be on key China data with trade and CPI due Thursday and Friday. Strong trade numbers and a lower CPI would be the best combination to ease concerns of a hard landing and boost risk sentiment.For all the latest currencies and forex rate news from the UAE and Gulf countries, follow us on Twitter and Linkedin, like us on Facebook and subscribe to our YouTube page, which is updated daily.
Subscribe to Arabian Business' newsletter to receive the latest breaking news and business stories in Dubai,the UAE and the GCC straight to your inbox.