August 21, 2012 / 12:41 PM / 5 years ago

FOREX-Euro rallies on speculation ECB will act

* Euro hits 2-week high vs dollar, 6-week high vs yen

* Talk of ECB action resurfaces

NEW YORK, Aug 21 (Reuters) - The euro rallied to a two-week high against the dollar and a six-week peak versus the yen on Tuesday, bolstered by talk the European Central Bank will take action to ease Spanish and Italian borrowing costs.

Uncertainties over the effectiveness of ECB bond-buying and worries over the euro zone's debt and economic problems were expected to limit the euro's gains however, and keep it hemmed below this month's high of $1.2443.

Talk of ECB intervention in debt markets resurfaced after a weekend report in Germany's Spiegel magazine that the central bank would target specific yield levels as part of any bond-buying programme.

The ECB tried to quash that speculation on Monday but traders cited a story in British newspaper The Daily Telegraph saying it could confirm the reports that ECB experts were examining plans to effectively cap Spanish and Italian yields.

While that does not advance the process of the ECB actually intervening - still largely dependent on German political leaders' attitude at key meetings next month - investors see that as evidence that the ECB is moving closer to action.

"The ECB must act in the bond market because threats, leaks and promises have a limited lifespan. Without ECB intervention Spanish and Italian rates will rise again as the countries no longer have the confidence of the credit markets," said Joseph Trevisani, chief market strategist at Worldwide Markets, Woodcliff Lake in New Jersey

The euro rose to $1.2438, its highest since Aug. 7 and close to the August 6 peak of $1.2443, hit days after ECB President Mario Draghi pledged to do all it takes to preserve the euro. It was last at $1.2435, up 0.8 percent.

Traders said it extended gains after triggering stop-loss buy orders on the break above $1.2400.

Although investors remained wary of aggressively selling the currency due to the possibility of ECB action, they were also reluctant to push it much higher.

The ECB holds its next policy meeting on Sept. 6 and European Union finance ministers meet on Sept. 14 and 15 - 10 days of action seen as critical for efforts to quell the crisis and keep Greece in the single currency.

"Meanwhile the market will be trading sideways," said Niels Christensen, strategist at Nordea in Copenhagen.

"If the euro breaks above the August high ($1.2444) the upside will be rather limited."

The euro rose as high as 98.84 yen, its strongest since early July.

The euro's gains against the dollar helped push sterling to a three-month high , while the Canadian dollar rose to a 3 1/2-month high against the U.S. dollar.

DIPLOMACY

French President Francois Hollande and German Chancellor Angela Merkel will meet on Thursday, a day before Greek Prime Minister Antonis Samaras arrives in Berlin.

Samaras is expected to lobby for a two-year extension of austerity measures to soften their impact, though he is unlikely to win major concessions.

The dollar rose 0.1 percent against the yen to 79.51 yen , but off the high of 79.66 yen hit on Monday, the highest since July 12. Selling by Japanese exporters is seen capping the currency for now.

The Australian dollar was last up 0.5 percent at $1.0494 lifted by Australian central bank minutes showing policymakers thought the full effects of previous interest rate cuts had yet to be felt.

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