The Australian dollar edged cautiously higher on Tuesday as recent tensions over sovereign debt in the euro zone seemed to ease.
Traders said there were hopes the EU could make progress on the debt troubles of Greece, Portugal and Spain at a meeting of government heads on Thursday.
European Central Bank President Jean-Claude Trichet surprised some by leaving a central bank symposium in Sydney a day early to attend the meeting.
Even the hint that concrete steps could be forthcoming triggered a wave of short-covering and lifted the euro above $US1.3700, dragging the Australian dollar with it.
The dollar crept up to $US0.8700, from $US0.8658 late on Monday and an early low of $US0.8614.
It had started under pressure after Wall Street took a late spill, but the market mood stabilised when Asian shares dodged the worst of the US weakness.
"Whether the recovery in risky FX represents seller fatigue after the carnage of last week or simply increased immunity from the litany of sovereign related rumours remains to be seen," said Sue Trinh, senior currency strategist at RBC Capital markets.
"Could it be a lot of the bad news is in the price for now?" Trinh said.
Resistance for the Aussie is now seen in the $US0.8710 to $US0.8735 area, with a break of 88 cents needed to counter the recent bearish trend and avoid re-test of $US0.8576.
The currency also nudged up to 77.80 yen, from an early 76.84 low.
Commodities were also faring somewhat better on signs Chinese and Asian demand was holding up well so far. The CRB index rose 1.15 per cent, LME copper added around 2.7 per cent and gold firmed to around $US1069.
There was no domestic data out on Tuesday though the RBA released a paper arguing central banks would need to become more pro-active in dealing with dangerous asset bubbles before they become destabilising to the financial system.
In a paper co-authored by Reserve Bank of Australia Governor Glenn Stevens, the central bank argued that keeping official interest rates too low for too long could inadvertently fuel imbalances.
The RBA led the G20 by raising interest rates last year and the current cash rate of 3.75 per cent is far above almost any other in the developed world.
The central bank's hawkish stance was enough to hit the short-end of Australian bonds and flatten the implied yield curve.
Three-year bond futures eased 0.020 points to 95.260, while ten-year futures added 0.020 points to 94.540.
Reuters
