LONDON: The euro hit a four-month high against a struggling dollar on Wednesday on expectations Germany's top court will approve a larger euro zone rescue fund, although it risked a selloff if the verdict disappointed.
The euro rose to $1.28866 on trading platform EBS, up 0.2 percent from late US trade on Tuesday. It gave up some of those gains as sovereign investors and hedge funds sold early in the European session.
Traders said the euro might rise past stop-loss orders at $1.2895 if the German Constitutional Court approves the country's participation in the euro zone's bailout fund. The ruling is due at 0800 GMT.
But traders were wary of any strings that the court could attach and which investors will scrutinise closely. That may lead to a modest drop in the euro towards $1.2750, traders said.
"The market is not looking for any surprise from the court," said Paul Robson, senior currency strategist at RBS Global Banking.
"But there is always a risk of strict conditionalities being attached by the court and if they are a lot stricter than what the market is expecting, we could see some profit-taking in the euro/dollar."
The euro has risen nearly 7 percent since touching a two-year low of $1.2042 in late July, helped by improving confidence towards euro zone assets after the European Central Bank unveiled a plan to lower peripheral countries' borrowing costs and by expectations of more monetary easing by the Federal Reserve.
The dollar index traded near a four month low at 79.869, with a warning from Moody's on Tuesday that it could cut the credit rating of the United States also weighing on the currency.
"Although everyone has been aware of the potential risks in the US fiscal situation, a warning at this time was a bit of a surprise and triggered fresh selling," said Teppei Ino, currency analyst at the Bank of Tokyo-Mitsubishi UFJ.
John Boehner, the top Republican in the US Congress, said he had no confidence a divided Washington could avoid a "fiscal cliff" that threatens to push the nation into a recession.
Expectations that the Fed will embark on further stimulus measures at its policy meeting ending on Thursday are likely to keep the dollar under pressure.
The Japanese yen held near 3-1/2 month high against a broadly weak dollar, trading at 77.85 yen per dollar.
"We think the Fed will announce QE3 this week and that the dollar will continue to fall after the Fed meeting, possibly to around 77 yen within a few weeks," said Junya Tanase, chief FX strategist at JPMorgan.
But market players said expectations that should the Fed announce large scale monetary easing, the Bank of Japan is also likely to take additional easing measures next week, were limiting yen gains.
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