The euro traded flat against the U.S. dollar and yen on Tuesday, recouping early losses with the help of U.S. central bank assurances that a bond-buying stimulus program will remain in place, limiting the attractiveness of holding the greenback.
Political gridlock in Italy, the euro zone's third-largest economy, following an inconclusive election is expected to keep the euro's short-term gains in check. This could prove only a temporary reprieve to the currency, which hit a seven-week low on Tuesday.
U.S. Federal Reserve Chairman Ben Bernanke adamantly defended the economy-boosting benefits of an $85 billion per month bond-buying program in testimony to the U.S. Congress.
The dollar recouped its losses against the yen in a late-day rally, helped by a rebound in U.S. Treasury yields following a steep drop on Monday due to the Italian election turmoil.
"Yields do have a strong impact on dollar/yen and support the move higher," said Eric Viloria, senior currency strategist at Forex.com.
Viloria noted that Italy's political turmoil is a major concern in the market. Wednesday's scheduled auction of 6.5 billion euros worth of 5- and 10-year bonds in Italy could prove a crucial element in determining investor sentiment.
The Italian stock market plunged while state borrowing costs rose after a stunning election in which a comedian's protest party led the poll and no group secured a clear majority in parliament. Euro zone shares sank to three-month lows.
Any coalition administration that may be formed must have a working majority in both houses in order to pass legislation.
"The bad part of the results is that there is now a 'hung parliament,' or divided government," said Christopher Vecchio, currency analyst at DailyFX in New York. "The lower and upper houses of parliament share power; thus, when each branch breaks into different ideological directions, the country is essentially at an ungovernable impasse."
The euro last traded at $1.3058, down 0.02 percent on the day. During early London trade, the euro touched $1.3017, its weakest since Jan. 7.
"For the euro, the focus is on the 2013 lows below $1.30, and events in Italy show that politicians are pushing back at fiscal austerity measures," said Paul Robson, currency strategist at RBS. "It is negative for the euro, and until it remains below $1.3170, it will remain a sell on rallies."
Against the yen, the euro reversed its course as well, finishing the day in the 120.20 yen area, up 0.27 percent. It had been trading near Monday's one-month low of 118.86 yen when it posted its single biggest percentage loss since early May 2011.
Despite its spurt higher in afternoon New York trade, the euro has been steadily losing ground. It is off a 15-month high against the dollar and a near three-year high against the yen. That is a swift turnaround from the start of 2013, when the euro rallied on hopes the worst of the euro zone debt crisis was over.
Bernanke Defends Policy
Bernanke strongly defended the U.S. central bank's bond-buying stimulus, saying its benefits clearly exceed possible costs.
He also urged lawmakers to avoid the sharp spending cuts set to take effect on Friday, which he warned could combine with earlier tax increases to create a "significant headwind" for the economic recovery.
The dollar last traded at 91.89 yen, up 0.10 percent on the day and not far from 90.92 yen on Monday, its lowest in nearly a month.
The focus on Italy temporarily took a backseat to U.S. economic data.
U.S. home prices closed out 2012 with the biggest annual gain in more than six years, according to the S&P/Case Shiller index, while government data showed sales of new homes spiked in January, the latest sign that the long-suffering housing market was on the mend.
Consumer confidence rose more than expected this month as Americans shrugged off worries about fiscal policy.