Euro near 14-month high after Fed sticks to stimulus

SYDNEY/SINGAPORE (Reuters) - The euro held near a 14-month peak against the dollar and a 2-1/2 year high versus the yen on Thursday, supported by expectations for central banks in the United States and Japan to keep an aggressive easing stance.

The U.S. Federal Reserve underscored that view by leaving in place its monthly $85 billion bond-buying stimulus plan on Wednesday, arguing the support was needed to lower unemployment.

The euro edged up 0.1 percent to $1.3579, nearing Wednesday's high of $1.3588, its strongest level since November 2011.

Seeming to support the Fed's cautious view, data on Wednesday showed the U.S. economy unexpectedly contracted in the fourth quarter. Still, a lot of that weakness came from a plunge in defense spending, suggesting the underlying fundamentals were not as bad as the headline figures indicated.

European data on Wednesday showed economic sentiment improved for a third straight month, a sign the euro zone is emerging from a low point and diminishing the chance of a rate cut from the European Central Bank.

With the euro having breached key resistance at $1.35, analysts say its rally may have more room to run.

"Euro/dollar we now think will rise to $1.37. The euro crosses are also likely to benefit from the return of exiled capital that left the euro zone," said Gareth Berry, G10 FX strategist for UBS in Singapore.

"Europe is not out of the crisis yet, there is still lots of uncertainty out there, but there has been enough stabilization to encourage some investors to return," he added.

News last week about euro zone banks' early repayments of three-year loans to the European Central Bank was seen as a sign that parts of the euro zone banking system may be on the mend.

Still, one reason to be cautious is a contrast between signs of decreasing financial market stress in the euro zone and the region's still lackluster economic fundamentals, said Daisuke Karakama, market economist for Mizuho Corporate Bank in Tokyo.

"Market-related gauges for the euro zone such as equities, government bond yields and credit default swaps...have shown a broad improvement," Karakama said.

But some economic indicators such as a record high unemployment rate paint a bleaker picture, he said. Data released earlier this month showed that the euro zone unemployment rate hit a record 11.8 percent in November.

"A rise toward $1.37 or $1.38 can't be ruled out on the back of the current trend, but I don't think you should view a move like that as one that is based on a positive view of (economic) fundamentals," Karakama said, referring to the euro.

YEN SEEN HEADING LOWER

Against the yen, the single currency held steady at 123.53 yen, near a peak of 123.87 yen set on Wednesday, which marked the euro's highest level against the Japanese currency since May 2010.

Expectations that new Japanese Prime Minister Shinzo Abe would push the Bank of Japan into more aggressive monetary easing to beat deflation have made selling the yen a one-way bet in the past few weeks.

The dollar slipped 0.1 percent to 90.97 yen, having hit a 2-1/2 year high of 91.41 yen on Wednesday, the greenback's strongest level versus the yen since June 2010.

"Yen depreciation has more room to go, in our view. We now look for the yen to depreciate to 96 and 100 versus the USD in 6 months and 12 months, respectively," analysts at Barclays Capital wrote in a client note.

Traders said the market focus will now turn to the U.S. employment report on Friday for the latest read on the health of the world's biggest economy.

(Editing by Simon Cameron-Moore)