The euro rallied on Wednesday to nearly a one-month high against the dollar and yen on hopes Slovakia would eventually approve an expansion of a program seen critical to containing the euro zone debt crisis.
The euro extended gains after surprisingly strong data on the region's August industrial output and as traders exited short positions against the single currency, analysts said.
China's yuan was firm against the dollar after the U.S. Senate passed a trade bill aimed at pressing Beijing to lift the value of its currency, raising tension between the world's two biggest economies.
"The market is repricing the risk of an 'end-of-the-world' scenario. The chance of a sharp recession has diminished," said Paresh Upadhyaya, head of Americas G10 FX strategy at Bank of America Merrill Lynch in New York.
The tentative optimism over the euro persisted despite the Slovak parliament's rejection on Tuesday of a plan to strengthen the European Financial Stability Facility (EFSF).
Investors took the view the government of Slovakia, the only member of the 17-nation euro zone block not to approve the plan, could gather a majority to endorse the 440-billion-euro fund by the end of the week.
"The rejection at the vote yesterday was expected. It would most certainly pass," said Nick Bennenbroek, head of currency strategy at Wells Fargo in New York.
Slovak TA3 television reported that parties in the outgoing government have reached an agreement with a leftist opposition leader on ratifying a plan to shore up the bailout program.
Investors also took comfort from German Chancellor Angela Merkel's comment that she was certain of ratification of the bailout fund's expansion by the October 23 European Union summit.
The euro was up 1 percent against dollar at $1.3791 after it broke an options barrier at $1.3700, which took it through a series of stop-loss entry orders above that. It touched a high of $1.38179 on the EBS trading platform, its strongest since Sept 16.
The euro also rallied against the yen, up 1.9 percent at 106.54 yen, the highest since Sept 15.
Traders said the euro's rise could be limited as the gains looked overdone, with concerns lingering about political hurdles to containing the euro zone crisis.
"This is a short-term technical squeeze without much fundamental support," said Bank of America's Upadhyaya.
U.S.-CHINA TENSION
Analysts said investors are wary about growing tension between the United States and China as a trade bill intended to pressure Beijing to loosen its currency policy makes its way to the U.S. House of Representative after the U.S. Senate passed it on Tuesday.
China urged the Obama administration to block the proposal that would allow the United States to slap duties on its products from countries found to be subsidizing their exports by undervaluing their currencies.
Despite heated exchanges between Washington and Beijing, analysts said it was unlikely the bill would become law.
Republican House Speaker John Boehner said on Wednesday he opposes the Senate-passed bill.
As long as China does not believe the United States would implement it, it is going to ignore it," Bank of America's Upadhyaya said.
But if chances of its passage grow, China -- which is the biggest U.S. creditor -- could retaliate, he added.
Worries China would take retaliatory steps were offset by moves among government-controlled Chinese banks, which appeared to have pumped dollars into the market, pushing the yuan to end at 6.3585 a dollar, up from Tuesday's close of 6.3750.
Outside of the yuan, the dollar touched a three-week low against a basket of currencies. The dollar index fell 0.8 percent at 77.585, above an earlier low of 76.796.
But the greenback strengthened versus the yen, touching its highest level in 4-1/2 weeks. It was last up 0.9 percent at 77.33 yen.
(Additional reporting by Jessica Mortimer in London; Editing by Andrew Hay)
