TOKYO: The euro briefly hit a one-month high against the US dollar on Monday after Greek parties supporting a bailout won a slim parliamentary majority, allaying fear of an immediate break-up of the currency bloc.
While there is scepticism in the market over the euro zone's ability to take effective steps to deal with the debt crisis that is now threatening Spain and Italy, massive speculative bets built against the currency could mean a good chance of further short-covering.
"This election results should keep hopes alive that Greece will stay in the euro," said Taisuke Tanaka, chief FX strategist at Deutsche Securities.
"There are massive short positions on the euro. Market players now need to consider whether the euro has more downside or upside, ahead of euro zone policy makers' meetings in coming days. I think risk currencies could recover some of their lost grounds," he added.
The euro rose to as high as $1.2748, near a 38.2 percent retracement of its decline from its February high of $1.34869 to two-year low of $1.2288 hit on June 1.
But it later gave up part of the gains on profit-taking and last stood at $1.2684, about 0.2 percent above its late US levels last week.
Some traders think the euro could test resistance levels such as $1.2904, a 61.3 percent retracement of its decline from May, ahead of European finance ministers meeting on Friday and EU summit at the end of this month.
Data from a US financial watchdog showed speculators in Chicago still held massive net short positions of 195,187 contracts last week, even after having trimmed them from previous week's record high of 214,148 contracts.
The huge bearish positions had been made on worries that Greece could leave the currency bloc if the leftists opposing the bailout had won the election.
The latest Greek official election results showed the two main pro-bailout parties were set to win 162 seats in the 300-seat parliament, beating the radical leftists who rejected austerity measures.
But analysts say any coalition could be short lived, and many market watchers believe a new government cannot hope to deliver on further austerity measures with the economy already into a fifth year of deep recession.
SPAIN NEXT FOCUS
One immediate focus is whether the Greek election results will help drive Spanish and Italian bond yields lower, some traders said.
"I think the essential problem facing markets right now has to do with Spain's financial institutions, and steps have already been taken to address that," Akira Hoshino, chief manager for Bank of Tokyo-Mitsubishi UFJ's foreign exchange trading department in Tokyo.
"The euro could test the upside this week, such as levels around $1.28 to $1.30, especially with the FOMC coming up," Hoshino said, adding that the dollar could see some weakness and the euro may find support ahead of the Fed's policy decision on Wednesday.
Many market players expect the Fed could extend its long-term bond buying through the Operation Twist by a few months from the current deadline of June, after a series of disappointing data.
In fact, the euro's recovery from its two-year nadir hit on June 1 has been driven not so much by its own strength as weakness in the US dollar based on speculation about more easing from the Federal Reserve.
The Australian dollar also hit one-month high of $1.0135 , and last stood at $1.0110. "There's a chance the Fed could adopt more of an easing bias at its policy meeting on Wednesday and that should cap the dollar for now," Peter Dragicevich, an FX economist at Commonwealth Bank of Australia.
Broad recovery in risk sentiment helped to push the yen lower from Friday's one-week high against the dollar, with the dollar trading at 79.19 yen, up 0.5 percent.
But some market players think a rally in the euro and risk assets could be fleeting, citing uncertainty over the shape of a new government in Athens and how Spanish banks will be rescued from the damage from burst in real estate bubble.
"For sustained gains in EUR in the days ahead, further 'encouraging' headlines will likely be needed from this week's G20 meeting and the later EU summit," said analysts at CitiFX in Singapore.
"We are sceptical that this marks the beginning of a new uptrend," they added.
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