NEW YORK The euro bounced from a one-month low versus the dollar on Thursday as easing concerns about Italy's government helped steady the country's bond yields, lowering fears about a financial bailout.
Italy moved closer to a national unity government, following Greece's lead in seeking a respected veteran European technocrat to pilot painful economic reforms in an effort to avert a euro zone bond market meltdown.
Italian 10-year bond yields steadied at around 7 percent, a level seen as unsustainable in the long term, due to signs that the political deadlock may be easing. Rome paid less to sell 1-year treasury bills than many had expected.
"Market participants have regained their appetite for risk and are retracing some of yesterday's losses, providing for a shift in focus toward fundamental data," said Eric Theoret, currency strategist at Scotia Capital in Toronto.
"Technicals continue to suggest bearish movement and directional indicators point to a recent acceleration in downward movement," he said. "The euro has gained despite the fact that major issues within the single currency remain unresolved."
A larger test looms for Italian debt on November 14 when an auction of five year bonds is set to take place, but near term support is likely to be found at $1.3480, he said.
The euro last traded up 0.3 percent at $1.3586, having earlier hit a session high of $1.3652, according to Reuters data.
The euro lost more than 2 percent on Wednesday, dropping by its most in 15 months against the dollar, as Italian bond yields reached 7 percent, a level viewed as unsustainable. Both Portugal and Ireland were bailed out after their bond yields exceeded that level.
Traders cited talk of large expiries at $1.3500 and $1.3600, which could sway trade. Support for the currency was seen at $1.3405 -- the 76.4 percent retracement of the euro's move from a low of $1.3144 on October 4 to a high of around $1.4247 on October 27.
The euro also found respite after news that former European Central Bank vice-president Lucas Papademos was poised to head a new crisis coalition in Greece.
"The euro will continue to be quite volatile," said Colin Harte, director of currency and fixed income at Barings Asset Management, which has around $40 million in currency hedge funds.
"The major change will only come when people know whether policymakers will commit themselves to some sort of major policy response or whether they will go to the printing presses to save Italy, which would result in a weaker euro."
Analysts said there were likely to be bouts of short-covering lifting the single currency as investors take profit on short euro positions. This will mean the euro will not move lower in a straight line, with any recovery likely to be sold into.
BEARISH OPTIONS POSITIONING
On the options market, one-month implied volatility -- a gauge of market expectations of the euro's moves versus the dollar -- surged to a one-month high around 16.50 percent from a low of 14.00 percent the previous session.
One-month risk reversals in euro/dollar -- a gauge of the premium demanded to buy bets on a currency falling or rising -- rose to record high levels around 4.15 vols in favor of euro puts, or bets on it falling.
Against the yen, the euro was flat at 105.46 while the dollar fell 0.2 percent to 77.64.
Sterling was flat on the day at $1.5926 after the Bank of England kept rates on hold at a record low 0.5 percent and left its asset purchase targets unchanged, as expected.