NEW YORK: The euro rose the most against the dollar in two weeks on Friday and may extend gains next week should an auction of Italian bonds go smoothly, easing fears over the country's ability to repay its debt.
Italy is slated to auction three billion euros of five-year government bonds on Monday. It will be closely watched by investors after Rome managed to sell five billion euros of 1-year debt this week that helped Italian yields stabilize below the critical 7 percent.
Trading could continue to be volatile and headline-driven, and the outlook for the euro remains bleak as the euro zone has yet to find a solution to prevent the debt crisis from engulfing its larger economies such as Italy and Spain.
"It's going to depend a lot on how the Italian auction goes," said Boris Schlossberg, director of FX research at GFT in Jersey City.
"Structurally, there's still a tremendous amount of pressure on the euro," he said. Even though rates have stabilized, "they are still extraordinarily high. It's the punitive cost of refinancing next year that's really going to weigh on all those European economies."
The euro last traded up 1.1 percent at $1.3747, after hitting a session peak of $1.3795 on Reuters data and well off a one-month low of $1.3481 set on Thursday.
Italy's Senate approved a new budget law Friday, clearing the way for approval of the package in the lower house on Saturday and the formation of an emergency government to replace the one led by Prime Minister Silvio Berlusconi.
The dollar slid as low as 77.051 yen on trading platform EBS, the lowest since Japan's massive yen-selling intervention on Oct. 31. It was last down 0.7 percent at 77.107.
Analysts said the latest sell-off puts intervention risk back on the radar screen, making short dollar/yen positions particularly risky.
GO LONG EURO/DOLLAR
On the week, the euro slipped 0.5 percent against the dollar, on pace for its second straight week of losses. The dollar declined 1.4 percent versus the yen, the biggest weekly drop since mid-August.
Goldman Sachs recommends investors go long the euro against the dollar, forecasting a bounce towards $1.40 as near-term policy uncertainty declines.
Former European Commissioner Mario Monti is widely expected to take over as head of a broad-based national unity government in Italy, a move many investors would welcome.
Adding to positive sentiment, Greece's newly appointed Prime Minister Lucas Papademos said the new national unity government will do its utmost to deal with the crisis-stricken country's problems.
"FX markets had started to price extremely negative scenarios again in recent days as visible in risk reversals for example," the firm wrote to clients. "These two developments (in Greece and Italy) suggest that euro zone fiscal tensions could continue to decline, at least for a period of time."
One-month risk reversals in euro/dollar traded around 4.1 in favor of euro puts, suggesting investors are still betting on further losses in the euro zone common currency. But the level of bearishness fell from Thursday when risk reversals hit 4.575 with a bias toward euro puts.
The US economic calendar next week is busy and investors will closely watch retail sales data on Tuesday. A positive reading could lift risk appetite and put pressure on the safe-haven dollar, analysts said.
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