The euro climbed broadly on Wednesday after stronger-than-expected German industry orders affirmed expectations the European Central Bank will not cut interest rates this week despite a steep fall in inflation.
Even so, the outlook for the euro zone's common currency has dimmed, with many market participants expecting the ECB to strike a dovish tone at Thursday's monetary policy meeting.
The euro has dropped sharply from levels above $1.38 touched before last week's data on inflation for the euro zone, which fell to the lowest level in nearly four years. The inflation numbers have fanned speculation the ECB may further ease monetary policy at some point, although Wednesday's robust German industry orders cemented views that the ECB will keep interest rates unchanged on Thursday.
Only one of 23 money market traders polled by Reuters expects a cut on Thursday.
"Our base case is that the ECB will strike a far more dovish tone on Thursday, laying the foundation for an interest rate cut and LTRO (long-term refinancing operation) at the Dec. 5th meeting,'' said Camilla Sutton, chief currency strategist at ScotiaBank in Toronto.
The euro extended gains after data showed German factory orders jumped by 3.3 percent in September, well above the 0.5 percent economists had expected.
In late afternoon trading, the euro was up 0.3 percent to $1.3517, well above Monday's low of $1.3441.
Ruben Segura-Cayuela, European economist at Bank of America Merrill Lynch in London, said the euro is not overvalued but is close to the upper end of its equilibrium range. He said the euro zone cannot afford a stronger euro.
"The strength of the euro this year has already started offsetting the periphery's competitiveness gains, which the region achieved during a painful adjustment in recent years,'' Segura-Cayuela said.
The euro has gained 2.5 percent so far this year, on track for its strongest yearly performance since 2007.
Another report on Wednesday showed that euro zone private sector growth slowed less in October than previously estimated.
Sterling earlier hit a one-week high against the dollar and a one-month peak against the euro after stronger-than-expected industrial output data.
``The outlook for the UK economy has improved notably following a string of better-than-expected economic releases,'' said Eric Viloria, senior currency strategist at Forex.com.
``However, as expectations increase it tends to be more difficult for positive surprises to continue.''
For more information on currencies, please click here.