The euro failed to hold early-session gains on Monday as investors focused on the likelihood of further political uncertainty in Europe over Italy's spending plans, despite a large drop in Italian government borrowing costs. Rating agency Moody's downgraded the Italian credit rating on Friday but unexpectedly kept the outlook at stable.
That, along with more conciliatory comments from Italian officials that they were ready to sit down with European Union officials and did not intend to expand the deficit beyond 2019, boosted demand for Italian debt after a weeks-long sell-off. But the euro, its fortunes increasingly linked this year to Italian bond prices, failed to hold on to early gains and dropped from $1.1550 to $1.1511, down 0.1 percent from the open.
"We have more conciliatory tones from both sides but it is still clear that this dispute is not over yet," Commerzbank analyst Thu Lan Nguyen said. "We are expecting volatile markets," she said, noting that investors would be looking to Thursday's European Central Bank monetary policy meeting to see whether, while unlikely, the bank would comment on the dispute.
Other analysts also said the euro remained at the mercy of Italian developments, with a great deal of uncertainty ahead.
"... A full diary of risk events over the next two weeks and little to argue in favour of support from the ECB in the near future, the question remains over how far the yield gap can blow out and how this could translate back into the FX market," BNY Mellon chief currency strategist Simon Derrick said.
The single currency was able to hold on to gains elsewhere, rising 0.1 percent to 1.1474 Swiss francs, and 0.3 percent versus sterling to 88.300 pence.
The dollar index rose 0.1 percent to 95.782.
Equity markets were mostly positive as hopes that China's tax cuts next year could be worth more than one percent of gross domestic product sparked a rally in Asian shares that fed across to Europe.
That helped offset geopolitical concerns about the rift between Saudi Arabia and the West over the killing of a prominent critic of the kingdom, as well as worries about Britain securing an exit deal with the EU.
Although the more positive tone at the start of the week did boost sentiment, forex markets were largely quiet.
The Australian dollar, which tends to benefit when China sentiment improves because of its exposure to Chinese demand, dropped 0.2 percent to $0.7105.
Elsewhere, the dollar rose versus the Japanese yen. The yen fetched 112.82, down 0.3 percent on the day and off a one-month high of 111.61 touched on October 15. Geopolitical concerns helped it to benefit from its safe-haven status.
The Canadian dollar changed hands at C$1.3087, within striking distance of a five-week low of C$1.3132 hit on Friday on the back of weaker inflation and retail sales. Sterling traded 0.2 percent lower at $1.3034 as markets prepared for British Prime Minister Theresa May's latest Brexit speech scheduled for Monday.
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