FOREX-Euro lags commodity currencies recovery on ECB risks
* Euro retains gains but still faces pressure before ECB
* Bets on range-trade in yen grow popular, implied vols down
* Aussie benefits from Australian growth data
By Anirban Nag
LONDON, March 6 (Reuters) - The euro lagged gains in growth-linked currencies on Wednesday, held back by concern that the European Central Bank could flag future interest rate cuts after its monthly policy-setting meeting on Thursday.
European stocks rose, mirroring the record high hit on the Dow Jones industrial average and lending support to commodity currencies like the Australian dollar. But the euro still has some way to go before it breaks above its downtrend since early February.
The key to the shared currency's near-term outlook is seen as ECB President Mario Draghi's stance on interest rates.
The ECB will announce its rate decision on Thursday and while it is widely expected to keep policy unchanged, staff projections for both growth and inflation are likely to be on the lower side, giving the central bank ample room to lower rates in coming months.
That could make any bounce rather fleeting and may leave the euro pinned down well below its 15-month high of above $1.37 struck in early February, traders said. Data later on Wednesday is likely to confirm the euro zone economy contracted by 0.6 percent in the fourth quarter of last year.
The euro was marginally higher at $1.30545, holding above a six-week trough of $1.2966 set on Friday. It was also slightly higher against the yen at 121.90 yen
"Investors are cautious about the euro before the ECB meeting tomorrow and there is always the risk that euro zone GDP could be revised downwards today and feed into fears that Draghi may strike a dovish stance," said Jeremy Stretch, head of currency strategy at CIBC World Markets.
"The euro is still a sell on rallies and any bounce above $1.3105 should be sold into."
BNP Paribas said in a note that the ECB's characterisation of inflation risks will be crucial. Should the ECB say downside risks to inflation have "increased" as opposed to "increasing" in its statement last month, the market pricing for a rate cut in April could increase, hurting the euro, it said.
The political stalemate in Italy following inconclusive elections is also likely to keep the euro subdued.
"There's reasonable downside to the euro. The situation in Italy is still uncertain," said Bill Diviney, currency strategist at Barclays.
The euro underperformed the growth-linked and higher-yielding Australian dollar dropping 0.2 percent on the day to A$1.2686. The Aussie benefited against a backdrop of improved risk appetite as the Dow Jones industrial average rose to new heights.
Against the dollar, it rose 0.2 percent on the day to $1.0280, extending its recovery from an eight-month low of $1.0116 hit on Monday. The Aussie was also helped by data showing moderate economic growth in Australia, supporting views that interest rates will remain steady rather than fall.
The Canadian dollar was steady at C$1.0271 per U.S. dollar, with the focus n a policy announcement by the Bank of Canada at 1500 GMT. Some are expecting it to tone down its previous hawkish stance following disappointing economic data.
The yen was steady against the dollar at 93.30 per dollar but traders see limited scope for further gains in the Japanese currency.
"Because Japanese policymakers have made it clear that it will keep aggressively easing, there will be fresh selling when it gains," said Koichi Takamatsu, forex manager at Nomura Securities.
The Bank of Japan kicks off its two-day policy-setting meeting on Thursday but the central bank is expected to hold fire this week and the market's attention is moving to April 3-4, the first policy review under new governor Haruhiko Kuroda.
Investors expect Kuroda, who is expected to be formally appointed as governor after confirmation by parliament, to inject fresh blood determined to beat deflation.
Traders said one increasingly popular strategy is to bet on the dollar/yen moving between 90-91 and 95 yen until April 4, the BOJ's likely first policy review under Kuroda, using option strategies.
This has helped the dollar/yen's implied volatility to ease, with one-month volatility at around 11.7 percent, compared to a 1-1/2-year high around 13.5 percent hit last week.