LONDON - The euro steadied against the dollar on Thursday but investors were cautious ahead of an Italian bond auction at which borrowing costs are expected to rise and Greek elections on Sunday that could lead to the country's exit from the euro.
The common currency dipped against the Swiss franc after the Swiss National Bank reiterated its commitment to defend a cap of 1.20 per euro on the franc's value.
Extreme bearish positions in the euro meant its losses were limited despite credit ratings agency Moody's downgrading Spanish government debt by three notches.
Many analysts said the euro was likely to trade in a range between US$1.24 (S$1.59) and US$1.27 ahead of Sunday's Greek vote, with investors reluctant to enter fresh short positions given uncertainty over the election outcome.
The common currency was last up 0.1 per cent on the day at US$1.2573 with offers expected around US$1.2610 and US$1.2670, near Wednesday and Monday's respective highs.
"The underlying problem of deteriorating confidence in sovereign debt in Europe is continuing to intensify, although unless there's a material weakening in demand at the Italian auction it's not really going to alter the FX market," said Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi.
"The euro has been relatively stable as we head into the Greek election and that will dictate market direction next week. Investors do not want to take on extra risk at this point."
Rome is due to sell up to 4.5 billion euros of bonds later in the session, with its cost of funds expected to rise sharply.
Italy, the euro zone's third-largest economy, is coming under pressure in financial markets as reforms undertaken by its unelected government have stalled and with no clear strategy emerging in Europe to end the broader debt crisis.
Concerns about Spain and Italy meant the euro may come under fresh pressure even if parties in favour of Greece's bailout programme win the election.
Victory for leftist SYRIZA, which is opposed to austerity measures on which Greece's bailout deals are conditional, would intensify fears of a potential euro zone break-up, and likely push the currency towards recent two-year lows around US$1.2280.
A sharp rise in yields on German Bunds, viewed as the euro zone's safest asset, has raised concerns that the cost of the debt crisis is growing even for the bloc's paymaster Germany.
"The fact that Bunds were sold for two days in a row is deeply disturbing," said Daisuke Uno, chief strategist at SMBC. "Investors may be starting to cut exposure to the entire euro area. And if you look at what's happening in Europe, it's hard to think they won't do that."