LONDON: The euro edged higher versus the dollar on Wednesday on cautious optimism that European leaders will take decisive action to contain the region's debt crisis at a summit later this week, but gains were capped by concerns that policymakers could disappoint yet again.
Strategists said the euro would also likely be supported ahead of a European Central Bank rate decision on Thursday.
The bank is widely expected to announce a rate cut and, following hints from ECB President Mario Draghi last week, some market players are also starting to position for the possibility the central bank may step up its crisis-fighting measures.
"The market has again and again bought into the idea of a comprehensive and convincing solution from policymakers so there is potential for some short-term upward movement in the euro today," said Ulrich Leuchtmann, head of currency research at Commerzbank.
The euro rose 0.3 percent to $1.3441, hovering above Tuesday's one-week low near $1.3334. Traders cited light stop-loss bids in the euro at $1.3470 and also near $1.3500.
Most strategists said although some investors were buying euros in anticipation of the ECB announcing a more forceful bond-buying programme, it was unlikely to do so as soon as Thursday given the ECB meeting comes before the European Union summit on Friday.
A key focal point of the summit is whether euro zone leaders make enough progress toward fiscal integration and more stringent fiscal discipline to open the way for the ECB to take a greater role in stabilising euro zone bond markets.
Investors are also focusing on possible initiatives to increase the capabilities of rescue funds that could help backstop euro zone governments hit by debt market turmoil.
Euro zone officials have said euro zone leaders may decide on Friday to raise the combined lending limit of their temporary and permanent bailout funds to boost the firewall they hope will contain spread of the sovereign debt crisis.
Analysts said expectations of progress at the summit were rising but any rally in the euro was likely to be limited to around $1.3550 in the short-term.
"Although it's supported against the backdrop of pretty strong expectations, I think there is certainly still some hesitation to be too optimistic given the disappointments we've had in the past," said Mitul Kotecha, head of global foreign exchange strategy for Credit Agricole in Hong Kong.
Disappointing results could drag the euro down to levels near $1.3215, with a clear breach of that support opening the way for a drop to the $1.3140/50 area, he added.
BUND AUCTION EYED
A German five-year Bund auction on Wednesday will also be scrutinised for any signs that contagion from the debt crisis is spreading to the euro zone's core economy.
Markets were rattled and the euro fell last month when Germany suffered one of its least successful debt auctions since the launch of the single currency, with investors put off by low returns.
The euro was flat against the Swiss franc at 1.2415 francs , after jumping higher the previous session following a steep fall in consumer prices.
Swiss consumer prices hit a two-year low, boosting speculation the Swiss central bank will raise the floor in euro/Swiss above 1.20 francs to shield the economy from the risk of deflation and recession.
There was talk of hedge funds buying euro/Swiss franc call options with a strike price at 1.2500 francs that are due to expire in the next week or two. In addition, traders cited talk of a large euro/Swiss franc option barrier at 1.2500 francs.
The Australian dollar rose 0.5 percent to $1.0284, holding firm after data showed Australia's economy grew a brisk 1.0 percent in the third quarter from the previous three months.
The dollar held steady versus the yen at 77.66 yen.
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