The euro paused below a 12-week peak today, though hawkish comments from the European Central Bank later in the day could give it fresh impetus to test resistance around $1.3950.
The euro could gain even more if Federal Reserve chairman Ben Bernanke, who is due to speak only a few hours after ECB chief Jean-Claude Trichet, reaffirms the bank's policy is still focusing on boosting growth.
The euro traded at $1.3798, having slipped on profit-taking after it marked a 12-week high of $1.3862 yesterday, though it is more than 7 per cent above a four-month trough of $1.2860 hit less than a month ago.
The euro moved little in Asia today, with many Asian players away for the Lunar New Year holidays and as traders looked to Mr Trichet's news conference at 1330 GMT.
"I think the market expects the ECB to be hawkish. But as the euro has already risen quite a lot, market players are cautious about chasing it higher," said Tsutomo Soma, a manager of foreign bonds at Okasan Securities.
Some market players suspect the market's expectations of hawkish rhetoric from Mr Trichet has built up so much that there is room for disappointment, posing downside risk for the single currency.
Similar risk also exists for the speech from the Fed chief, due at 1730 GMT, if he turns out to be less dovish than many market players have hoped.
Still, Fed governor Elizabeth Duke said late yesterday that although she does not think the US central bank will have to extend its $600 billion bond-buying programme beyond midyear, economic weakness could force the Fed's hand.
Many market players do not expect the speeches from the world's two most influential central banks to change the perception that the ECB will be way ahead in raising interest rates to curb inflation.
That should keep euro zone interest rates much higher than dollar rates, and help the euro test resistance around $1.3950, where it has a 76.4 per cent retracement of its two-month decline to early January as well as its 200-week moving average.
In addition, worries on the euro zone's debt problems are falling off many market players' radars as yields on Spanish and Italian government bonds fell sharply to two-month lows.
Although the euro dipped slightly on news that supporters of Egyptian President Hosni Mubarak opened fire on protesters in Cairo, the impact was limited.
"At the moment, it looks like a skirmish. If the army starts firing, that would be a different story, but that doesn't seem to be the case," said a trader at a Japanese bank.
Expectations of a credit tightening are also helping the British pound stay close to a three-month high. Sterling stood at $1.6194, not far from yesterday's three-month peak of $1.6232.
While interest rate differentials are seen playing a big role in currency transactions, one currency pair that has seen a breakdown in correlation with yields is the dollar/yen.
The yield on US two-year notes, which had strong correlation with dollar/yen moves last year, has almost completely lost its link to dollar/yen in the past month.
The US two-year bond yield rose to its highest in nearly a month yesterday but that had a limited impact in boosting the dollar versus the yen and the one-month correlation of the two assets is now close to zero.
"The market seems to no longer be looking at yield gaps. What's we are seeing is that investor buying of bonds is dwindling. Instead, their money seems to be heading for commodities," said Katsunori Kitakura, chief dealer at Chuo Mitsui Bank.
Indeed, Japanese government data showed Japanese investors became net sellers of foreign bonds last week for the first time in six weeks.
Worries about inflation - the enemy of bonds as it eats into their real value - helped to push 30-year US bond yields to a nine-month high yesterday.
The Australian dollar rose 0.1 per cent to $1.0103, inching closer to a one-month peak of $1.0149 marked earlier in the week as it drew support from strong Australian trade data.
But the New Zealand dollar dropped sharply after a surprise jump in unemployment.
Reuters