(Reuters) - The euro climbed against the dollar on Wednesday after three days of losses, as investors squared up positions ahead of a Federal Reserve policy decision that could allude to further monetary easing.
Investors in general do not expect drastic action from the Fed, given the improvement in U.S. data the last few weeks, but some said the central bank may drop hints about additional measures to further spur the economy.
Overall though, Europe's sovereign debt problems remain an overriding concern for many, with the euro still vulnerable to the downside. Investors remained fearful about the risk of Greece's default after Prime Minister George Papandreou called for an unexpected referendum on a bailout package hashed out at last week's European Union summit.
"This gain in the euro is just a modest uptick until the next shoe falls," said Ron Simpson, director of currency research at Action Economics in Tampa, Florida.
He also attributed part of the euro's gains to a reduction in long U.S. dollar positions in case the Fed surprises the markets and announces another round of quantitative easing.
That said, the overall tone was risk-friendly, with some market participants trying to put a positive spin on bits of news on Wednesday. For instance, reports indicated that the Greek referendum may be held either on December 4 or 11 and the mention of a specific date was viewed as positive for the euro.
"There's somewhat a better understanding of the picture pertaining to Greece. With the referendum coming in front of Christmas, that means we have a shorter timeline to wait for a decision on that," said Stewart Hall, senior currency strategist at RBC Capital Markets in Toronto.
He added that markets were expecting the referendum to be held in January.
In midday New York trading, the euro was up 0.9 percent at $1.38140, pulling away from the three-week low of $1.3608 struck on Tuesday, amid a bout of short covering by real money investors and speculators.
It rose to a session high of $1.38294 on trading platform EBS, with near-term resistance around $1.3845 -- the 50 percent retracement of the euro's drop from its Aug 29 high of $1.4550 to a low of $1.3145 on October 4.
The euro held gains despite weak manufacturing PMI data from Germany, France and Italy, which backed views that the euro zone is tipping toward a deep slowdown and compounding the euro's struggles.
Investors also are looking ahead to the Greek government's confidence vote on Friday. If Papandreou loses the vote, a new general election will be called and most likely there will be no referendum.
But any such outcome is likely to spark renewed uncertainty and increase the chances of a disorderly default by Greece and the risk of contagion to other countries like Italy and Spain.
Papandreou also will face the leaders of France and Germany, who summoned him for crisis talks in Cannes, before a G20 summit of major world economies.
The options market also indicated a fair amount of pessimism about the euro, with volatility still at elevated levels, suggesting investors see more need to hedge against any negative events that may come out of Europe.
Implied volatility on one-month euro/dollar options, a gauge of expectations regarding a currency's price action, were last at 15.40 percent, according to Reuters data, from roughly two-month lows of 12.75 percent last week.
The euro, however, could gain some relief as investors' attention turns to the outcome of a meeting of the Fed's policy-setting FOMC ending on Wednesday, which may prepare markets for further policy easing.
The Fed will release its post-meeting statement at 12:30 p.m. (1630 GMT), and Chairman Ben Bernanke will hold a media briefing at 2:15 p.m. (1815 GMT).
The dollar lost 0.4 percent to 77.990 yen. Japan sold a record of nearly $100 billion worth of yen on Monday, driving the greenback from a record low around 75.31 yen to a high of 79.55 yen.
