NEW YORK: The euro rose against the dollar on Tuesday, ending two days of declines, and commodity-linked currencies advanced as risk appetite improved after better-than-expected German economic data and strong Chinese growth figures.
Solid demand at Spain's Treasury-bill auction also boosted the euro and helped ease recent downward pressure, although investors said the latest rally was a temporary correction.
The euro will once again be tested when Germany and Portugal hold debt auctions on Wednesday. Spain and France also come to the market with large coupon issues on Thursday.
Overall, the euro's outlook remained bleak after Standard & Poor's downgraded the euro zone's EFSF rescue fund by one notch to AA+ on Monday following a raft of sovereign rating cuts on Friday. Analysts said the euro could retreat toward a 17-month low versus the dollar hit late last week.
"The positive data out of Europe was a surprise, and that prompted a lot of short-covering in the euro, but my guess is that this rally is not sustainable because sentiment on the euro is so negative, especially after Friday's downgrades," said Brian Kim, currency strategist at Royal Bank of Scotland in Stamford, Connecticut.
Risks of a Greek debt default are also likely to see investors sell into rallies, with the prospect of more cuts in official euro zone interest rates also hanging over the common currency.
In late afternoon New York trading, the euro rose 0.5 percent on the day to $1.2723, according to Reuters data. Traders said a semi-official investor was said to be a buyer of euros after the biggest-ever jump in the German ZEW sentiment survey. Talk of macro fund demand around $1.2770 lifted the euro to the day's high of $1.2808. But further gains were capped by stop-loss orders above $1.2810.
The euro's rise on Tuesday and the overall increase in risk appetite have pushed euro/dollar one-month implied volatility lower to 11.76 percent from a high of 13.13 percent on Monday. Lower volatility suggests higher tolerance for risk.
Analysts at Danske Bank said the euro remains anchored fundamentally and "as long as an EMU (European Monetary Union) break-up or multiple sovereign defaults are not seen, we do not expect a collapse in euro/dollar below $1.20."
The euro, however, trimmed gains earlier against the dollar after the European Commission said it will launch legal action against Hungary over the country's laws on its central bank, judiciary, and data protection.
The EU Commission said changes to Hungary's laws are a precondition for the resumption of talks on financial assistance for the country.
The euro also climbed against the yen, rising 0.5 percent to 97.75 yen, recovering from an 11-year low struck on Monday.
Speaking in the wake of the recent slide in euro/yen, Japanese Finance Minister Jun Azumi said he was closely watching the impact of a weak euro on Japanese exporters.
Apart from expectations of rate cuts from the European Central Bank that will erode the premium investors get for holding euros instead of dollars, the risk of a default by Greece in coming months and the possible ramifications for other peripheral countries are likely to weigh on the common currency.
The market will keep a close eye on talks between Greece and its private sector creditors on a debt swap deal that broke down last week but which are expected to resume on Wednesday.
Cash-strapped Athens needs a deal with the private sector soon to avoid going bankrupt when 14.5 billion euros of bond redemptions come due in late March.
The Australian and New Zealand dollars outperformed the greenback and rose to their highest in two-and-a-half months after China's fourth-quarter growth just exceeded market expectations.
"Stronger-than-expected Chinese data overnight fuelled a risk rally that carried over into European trade as growth concerns from the Asian juggernaut temporarily eased," said Michael Boutros, currency strategist at DailyFX.com.
Gross domestic product in China, the world's second-largest economy and a key driver of global growth, expanded at an annual rate of 8.9 percent, although that remained the weakest in 2-1/2 years and was down from 9.1 percent the previous quarter.
The Australian dollar last changed hands at US$1.0366, up 0.6 percent. The New Zealand dollar last traded at US$0.7989, up 0.9 percent.
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