The euro rose on Monday after Italy unveiled austerity measures and on expectations that European Union leaders will come up with a credible and comprehensive plan to tackle the eurozone debt crisis at a summit later this week. French President Nicolas Sarkozy and German Chancellor Angela Merkel, under pressure to align their positions on centralising control of eurozone budgets, meet in Paris on Monday to outline proposals to put to the December 9 summit.
Analysts and traders said the euro may gain as investors take profits on hefty short euro positions before the summit, though it will stay vulnerable to renewed bouts of selling if there are suggestions leaders are struggling to reach agreement. "The market wants to see some kind of concrete agreement before investors are prepared to liquidate short positions," said Niels Christensen, currency strategist at Nordea in Copenhagen.
"I see the euro trading sideways for now. We may need to see negative news that there won't be any fresh agreement for it to test last week's lows." The euro was up 0.3 percent versus the dollar at $1.3440, holding above last week's low around $1.3259 and the November 25 low of $1.3213, having touched a high around $1.3460. Traders cited offers around $1.3480 ahead of stop loss orders placed above $1.3500.
Showing just how pessimistic speculators have become on the euro, data from a US financial watchdog on Friday showed speculators on the Chicago futures exchange had their largest net short position in 18 months last week. The poor state of the eurozone's economy was underlined by business surveys suggesting there will be a steep economic contraction in the current quarter.
However, market players took encouragement as Italian Prime Minister Mario Monti unveiled a 30 billion euro package of austerity measures on Sunday. Many are hopeful the EU will have taken a step towards fiscal union by Friday, agreeing on a treaty change to anchor coercive budget discipline for the 17-nation currency area. But that outcome is far from certain given the difficulties in securing agreement from so many countries.
Also in focus this week is a European Central Bank policy meeting on Thursday, which is expected to result in a cut in interest rates and fresh liquidity measures for banks, if not more sovereign bond buying. Although a rate cut would normally be negative for the euro, analysts expect the single currency would come under selling pressure if the ECB fails to take action to help the economy and temper the debt crisis.
"Paradoxically, if the ECB fails to cut interest rates from 1.25 percent, the euro is likely to slide sharply as investors will feel the central bank is gravely underestimating the crisis it faces," Mansoor Mohi-uddin, head of FX strategy at UBS said in a note to clients. A Reuters survey of 73 analysts showed a 40 percent chance the ECB will in the next six months start purchasing government bonds from struggling eurozone economies using freshly created money, which European policymakers have so far resisted.
"If the ECB continues to take a very hard line then euro/dollar would go lower," said RBS currency strategist Paul Robson. Some of that wariness was reflected in the options market where near term implied volatilities traded stubbornly high, with the one-week trading at 14.75 percent.
Risk sensitive commodity currencies drew some comfort from higher stock markets and Friday's data, which showed the US unemployment rate fell to a 2-1/2 year low in November, extending a string of better-than-expected US data. The Australian dollar was up 0.4 percent at $1.0252, while the dollar index, which measures the performance of the US unit against a basket of currencies, was down 0.27 percent at 78.417. A Reserve Bank of Australia (RBA) policy meeting was awaited on Tuesday, where analysts see a good chance it will cut rates for the second month in a row.