The U.S. dollar fell on Wednesday as the euro recovered from 10-month lows after reports that Italy's biggest party would make a renewed attempt to form a coalition government and end months of political turmoil.
An attempt by two anti-establishment parties to form a new government in Italy collapsed over the weekend, raising the prospect of an early election. Markets feared that election would become a de facto referendum on Italy's use of the euro.
A source close to 5-Star, the single largest party in the new parliament, said it would try again to form a coalition with the right-wing League. Without a deal, sources said President Sergio Mattarella could dissolve parliament in the coming days and send Italians back to the polls as early as July 29.
The euro rallied and Italian government bond yields settled below multi-year highs after Tuesday's market slide.
The dollar index, which tracks the greenback against a basket of six currencies, was down 0.71 percent on Wednesday to 94.16, below Tuesday's 6-1/2-month high.
The dollar gained 0.16 percent against the at 108.92.
"We're seeing a relief trade today. Markets passed through the panic from yesterday so everything that sold off hard is climbing back, the euro in particular," said Greg Anderson, global head of FX strategy at BMO Capital Markets in New York.
A smooth auction of Italian government debt also helped soothe market jitters.
The single currency, which plunged to a 10-month low of $1.1510 on Tuesday, rose as much as 0.9 percent to a session high of $1.1647 on Wednesday. It remains down 4 percent this month against the dollar.
The rose as much as 1.2 percent on Wednesday after the country's central bank held interest rates steady but suggested that it could raise rates soon, possibly as early as July.
"The bottom line is that they'll be hiking in July unless some surprise occurs," Anderson said. He noted that the loonie on Wednesday "appreciated in an important way, not just against the dollar, but across all axes, for example, Aussie/CAD."