Resilient Euro May Be Giving Up the Fight
The euro has been expected to fall against a broadly robust U.S. dollar for some time and it finally appears to be succumbing to sustained selling pressure, hovering around a three-month low.
What's changed for the single currency, analysts say, is a clear commitment from the European Central Bank at last week's policy meeting to keep interest rates low for some time – a policy that contrasts sharply with a Federal Reserve that could start unwinding its monetary stimulus later this year.
(Read More: Wall Street Bumps Up Fed Taper Forecast: CNBC Survey)
The euro hit a three-month low on Tuesday at about $1.2754 after Italy's sovereign credit rating was cut by ratings agency Standard & Poor's and ECB policymaker Joerg Asmussen was reported saying that the ECB's guidance on interest rates staying at record lows extends beyond 12 months.
Although the ECB issued a statement saying that Asmussen had not intended to give any guidance on the length of time that rates would stay low, strategists say the comments highlight the divergence between U.S. and European monetary policy.
"Asmussen has given the market a frame of reference. As much as the ECB may say 'we're not ready to slap a timeframe on this,' 12 months is what everyone is going to start looking at," Kathy Lien, managing director at BK Asset Management, told CNBC Asia's "Squawk Box."
"The story is monetary policy divergence and that is why we will get the euro falling, sterling falling. Because we are getting the Federal Reserve being the semi-quasi hawk while everyone else is cowering in the corner, so this will continue to have an impact on markets in coming months," she added.
The ECB last week departed from its traditional policy of not committing to future plans by saying it would keep rates at present or lower levels for an "extended period." The ECB's key rate is at a record low of 0.5 percent.
(Read More: ECB's Draghi Defends Interest Rate Guidance)
"We remain of the view that euro/dollar should be sold on rallies as there is little scope for investors' ECB monetary policy expectations to adjust higher anytime soon," analysts at Credit Agricole said in a research note. "This is especially true as ECB Executive Board member Asmussen just recently stressed that forward guidance goes beyond 12 months."
Euro 3-Month Chart
Major and emerging market currencies have fallen against the dollar in recent weeks amid expectations for the Fed to start taking back its hefty monetary stimulus for the U.S. economy sooner rather than later.
Amid the heightened volatility in currency markets, the euro has held up relatively well and analysts have attributed that in part to safe-haven flows from emerging markets as well as continued inflows into peripheral euro zone debt markets.
(Read More: Asia 'Shivers' as Fed Tapers, China Slows)
The euro is down about 4.8 percent from a high hit in mid-June and many analysts expect the currency to fall towards $1.25 in coming weeks, implying a fall of another 2 percent from current levels. This would take it to its lowest level since September 2012.
"We are now dropping into a lower trading range for the euro, which had seen some resilience thanks to position cutting towards emerging markets. It is clear that has progressed to some extent, which leaves the euro more vulnerable to this dovishness from the ECB," said Citi's currency strategist Todd Elmer.
—By CNBC's Dhara Ranasinghe; Follow her on Twitter: @DharaCNBC