LONDON The euro recovered slightly from a two-month low against the dollar on Monday, helped by higher short-term market interest rates, although speculation the European Central Bank may step in capped gains.
After breaking through support at $1.3550 (825 pence) on Friday, the euro fell in Asian trading on Monday to its lowest since November 25 at $1.35080. It later recovered some ground, and was 0.1 percent higher at $1.3560 in London trading.
A U.S. market holiday kept a lid on volumes.
The single currency has weakened this month as year-end factors such as euro zone banks repatriating assets fade. Speculation the ECB will loosen monetary policy further means even a rise in overnight borrowing rates has failed to lift it.
"We think that (the) key driver of the recent euro underperformance is growing market expectations of ECB action to address the tightening money market conditions," Citi strategist Valentin Marinov said.
Eonia, the euro zone overnight bank-to-bank lending rate, topped 0.30 percent on Friday, above the headline 0.25 percent rate that banks pay when they borrow at the ECB's still unrestricted lending operations.
After the ECB's January policy meeting, bank President Mario Draghi said an "unwarranted" rise in interbank lending rates that underpin euro zone borrowing costs would be one of two possible triggers for another rate cut or other action.
One trader said the euro's rise may squeeze out some short-sellers but that the single currency could then head lower again. Positive sentiment towards the euro has moderated, with investors betting it will fall adding to their positions for four consecutive weeks, according to a report from Scotiabank.
"The market has been focusing on broad dollar strength against everything except the euro ... The euro was playing catch-up," said Chris Turner, head of FX strategy at ING, referring to the euro's overnight weakness.
Turner said he expected the euro to fall to $1.33 this week and to $1.20 by the end of the year against a strengthening dollar as the Federal Reserve cuts back its bond-buying programme and as euro zone residents begin to invest abroad.
Investors were left looking for direction, with little economic data from Europe, other than German December producer prices that were slightly above forecast.
The dollar index was 0.2 percent lower at 81.069 and the U.S. currency was down 0.25 percent at 104.05 yen after U.S. Treasury yields fell on Friday.
The Australian dollar got some relief after China's economy grew in the final quarter of 2013 at an annual 7.7 percent, down from 7.8 percent in the previous three months but slightly above market expectations.
The Aussie gained 0.4 percent to $0.8810 after earlier falling to $0.8756, its lowest in about 3-1/2 years, in the wake of weak jobs data last week. Traders said the 87 U.S. cent area should provide good support, as it did in 2010, although a break could see it test $0.8600.
Forex.com research director Kathleen Brooks pointed to rising inter-bank lending rates in China, a major export market for Australia.
"If we see another spike in rates as we lead up to Chinese New Year on January 31...we may see (Chinese) stocks take another dip lower, which could weigh on the Aussie," she said.
(Efiting by Alison Williams and Nigel Stephenson)
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