The euro was on the defensive today after European Central Bank president Jean-Claude Trichet poured cold water on expectations for a near-term rate hike, wrongfooting bulls who had expected more tough talk on inflation.
Whether the euro's retreat from a 12-week high will continue now hinges on US job data due later in the day, with a break of support around $1.3535-70 seen as a potential sign of more losses down the road.
Mr Trichet, speaking after the ECB's decision to keep rates at a record low 1 per cent yesterday, said inflation expectations remain "firmly anchored" and inflationary pressures over the medium to long term "should remain contained".
His comments disappointed investors who expected a more hawkish statement after recent inflation data came in above forecasts. Expectations the ECB would lift interest rates sooner than the Federal Reserve had boosted the euro in recent weeks.
The euro traded at $1.3625 after falling 1.2 per cent the previous day, moving further away from a 12-week peak of $1.3862 set on Wednesday.
On charts, the euro is now clutching at support from an Ichimoku cloud top at $1.3626.
More supports lies at $1.3570, this week's low, and $1.3535, which was resistance for the currency last month before a break there turned it into support.
A breach of those rates would open the door for a slide below $1.35 - a scenario some analysts view as likely.
"I think the market's expectations of ECB rate hikes had gone a bit too far," said Ayako Sera, a market strategist at Sumitomo Trust and Banking.
Mr Trichet's comments prompted euro zone interest rate futures to reflect a rolling back of expectations of a rate increase by August to around 80 percent from fully pricing it in before.
The market will be watching an EU summit later today, although few traders expected a surprise as any measures to reinforce its bailout scheme are expected to be taken in March.
More important will be US jobs data due at 1330 GMT, with market players expecting it to show jobs growth of 145,000 in January.
Some traders think a stronger reading would favour the dollar at the expense of the euro.
"US bond yields seem about to go above their recent ranges. If they do, that will likely lead to a broad recovery in the dollar," said a trader at a Japanese bank.
But others think the market reaction may not be straightforward as the euro could benefit from rising risk appetite, especially if the data fails to change the perception that the Federal Reserve is no hurry to raise rates.
Fed chairman Ben Bernanke said yesterday that despite improved data the US economy needs help from the central bank. US short-term interest rates futures suggest traders have raised their expectations that the Fed could increase rates at the end of the year in a bid to keep a lid on inflation.
Bolstering those expectations and the dollar's rebound were reports showing the US services sector grew in January at its fastest pace since August 2005 while new weekly claims for unemployment benefits dropped sharply.
The dollar index showing its value against a basket of currencies rebounded sharply yesterday but moved little today at 77.74, off a 12-week low of 76.881 hit earlier this week.
The dollar was little changed against the yen at 81.61 yen, drawing little help from a rise in US bond yields - a sea change from last year when the pair closely tracked US debt yields.
Although the two-year US bond yield climbed to a new one-month high of 0.73 per cent and looks set to rise to an eight-month peak if the US job data turns out to be strong, the dollar hovered not far from a one-month low of 81.31 yen hit earlier this week.
The Aussie dollar jumped to a one-month high after the Reserve Bank of Australia stayed resolutely upbeat on the economic outlook and played down the temporary impact of recent floods, leading investors to price in higher interest rates. The Aussie rose as high as $1.0196, not far from a 28-year high of $1.0257 hit last year.
Reuters
