(Reuters) - The euro edged up against the dollar on Thursday as some sovereign investors pared recent bets against the single currency before a European Central Bank interest rate decision.
Traders, though, said gains were likely to be fleeting and the euro could weaken towards three-month lows against the dollar if ECB chief Mario Draghi hints at interest rate cuts at his press conference at 1330 GMT.
Traders also said there was an outside risk the euro could rebound slightly if Draghi did not sound too downbeat about the euro zone's prospects.
Even so, the euro is likely to struggle at higher levels given investors are snapping up the dollar on the back of good U.S. economic data and expectations the U.S. federal Reserve may halt its asset purchase programme towards the end of the year.
In contrast, the ECB is likely to downgrade its staff projections for inflation and growth, all of which could see interest rate differentials move in favour of the dollar.
The central bank, which meets in Frankfurt against a backdrop of political deadlock in Italy, is however, expected to keep rates on hold for now.
The euro was up 0.4 percent at $1.3023. But it stayed susceptible to losses and could retest last week's near three-month low of $1.2966. That is serving as a support for now, below which the euro could fall to December's low of $1.2876. Resistance was cited at $1.3126, the euro's 100-day moving average.
"We don't expect anything from the ECB but a small minority is looking for a rate cut today and that is partially built into the price," said Adam Cole, global head of FX strategy at RBC Capital Markets. "If the ECB stays on hold, we could probably see a small bounce in the euro."
The dollar index last stood at 82.343, having risen as high as 82.604, its highest since August 20, in late Wednesday trade. It has rallied more than 4 percent from this year's trough of 78.918 plumbed on February 1.
The U.S. currency was helped by solid jobs data on Wednesday fuelling optimism of an economic recovery which could prompt the Federal Reserve to wind up its massive stimulus programme.
Sterling meanwhile fell to a 2-1/2-year low earlier on Thursday, as some in the market positioned for more stimulus from the Bank of England as early as on Thursday as the British economy faces the threat of a triple-dip recession.
The pound was down 0.2 percent against the dollar at $1.4985, close to $1.4965, its lowest since mid-July 2010.
DOLLAR STRENGTH
Better-than-expected U.S. jobs data on Wednesday bolstered hopes that Friday's U.S. non-farm payrolls will surprise on the upside and the Fed might be the first major central bank to pull the plug on stimulus, while the others continue to ease.
"One reason the dollar is broadly strong could be that while the world's many other central banks are eyeing more easing, at least at the Fed the debate is about exiting from stimulus, not doing more of it," said Teppei Ino, currency analyst at the Bank of Tokyo-Mitsubishi UFJ.
Earlier on Thursday, the Bank of Japan stayed on hold although the yen weakened against the dollar on expectations of aggressive policy easing in the future.
Against the yen, the dollar was flat at 94.00, moving closer to a 33-month peak of 94.77 reached on February 25.
But hefty selling above 94 yen, from option traders as well as Japanese companies repatriating overseas profits ahead of their March 31 book-closing, could cap further gains.
The BOJ meeting on Thursday was the last policy meeting chaired by outgoing Governor Masaaki Shirakawa, with markets expecting fresh stimulus measures at one of its meetings in April under a new governor.
