NEW YORK: The euro climbed to a four-month peak against the dollar on Wednesday after Germany's Constitutional Court approved the euro zone's new rescue fund and budget pact, mitigating concerns about the region's three-year-old debt crisis.
While the court approval was made under certain conditions, it was enough to lift market sentiment, boosting global stocks and reducing borrowing costs for Spain and Italy.
The euro climbed to $1.2936, its highest since mid-May, blowing past reported option barriers at $1.2900. The single euro zone currency has risen more than 7 percent since it hit a two-year low of around $1.2040 in July, boosted after the European Central Bank's pledge to do whatever it takes to preserve the currency. More gains are expected if the Federal Reserve opts to implement further monetary easing on Thursday, leaving the euro with the potential to test the $1.30 level.
"The euro continues to be in steady favor as a series of events have proven to be supportive, including today's ruling by Germany's top constitutional court," said Samarjit Shankar, managing director of global strategy at BNY Mellon in Boston.
Germany's Constitutional court said on Wednesday the European Stability Mechanism could go ahead but with the condition that any German contribution above 190 billion euros would require prior approval by the lower house of parliament.
Positive momentum continued for the euro as well as higher-yielding currencies following the European Central Bank's unveiling of plans last week to lower the borrowing costs of indebted euro zone countries via bond purchases.
But analysts and traders still worried that the depth of the euro zone's debt problems could temper the euro's rise.
"It is now time to take stock. How much further can the Euro rally?," asked Jens Nordvig, head of G10 FX strategy at Nomura Securities in New York.
He believed that there would be fewer positive European catalysts from here on and said "the short-squeeze on the euro is now in its final phase, and we will be looking for fresh short opportunities."
Traders reported another options barrier at $1.2950 and cited chart resistance at the May 11 high of $1.2958. The euro traded well above a low of $1.2815 hit on caution just ahead of the court decision.
The euro was last up 0.4 percent versus the dollar at $1.2904.
It also rose to its highest in more than two months against the Japanese yen of 100.64 yen. In midday New York trading, it was at 100.44, yen, up 0.5 percent.
Currency markets showed little reaction to the killing of the US ambassador to Libya and three other embassy staff on Wednesday, which pressured crude oil futures.
A potential source of disruption for the euro, however, is a general election in the Netherlands on Wednesday, though polls indicate radical anti-euro parties have lost the momentum they had just a month ago.
DOLLAR FALLS BEFORE FED
The dollar fell to a four-month low against a basket of currencies before Thursday's Federal Reserve decision, with the dollar index dropping to 79.522.
BNY Mellon's flows data showed that the dollar was the most sold sold currency across the board on Wednesday, with sterling and the Canadian and New Zealand dollars the most bought.
The Fed looks set to launch a third round of bond purchases this week to try to drive borrowing costs lower and boost a flagging economy, especially after weak jobs data last week.
However, analysts said expectations for more QE were already high which may limit the currency's drop.
The dollar extended losses following a warning from Moody's on Tuesday that the United States could lose its triple-A debt rating if next year's government budget talks do not produce policies that gradually cut the country's debt.
The dollar also fell to a four-month low against the Swiss franc of 0.9337 franc, while the higher-yielding Australian dollar hit a three-week high of US$1.0507.
The Swiss National Bank is expected to keep its target range for the Swiss franc LIBOR unchanged and retain its cap on the euro/Swiss franc currency pair at 1.20 francs when it announces its monetary policy decision on Thursday.
The yen held near a 3-1/2-month high against the broadly weak dollar, trading at 77.88 per dollar. Focus on potential Fed action this week compared to a Bank of Japan viewed to be on the sidelines should keep pressure on the dollar for now.
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