FOREX-Euro rests near 2-year highs vs dollar as more gains seen

* ECB policy meeting seen as supportive for single currency

* Test of $1.20 may be on the cards

* Option bets go wrong prompting euro short-covering

By Saikat Chatterjee

LONDON, July 21 (Reuters) – The euro held near a two-year high against the dollar on Friday as investors took the latest European Central Bank meeting as a sign that policymakers weren’t greatly concerned about recent currency strength.

Euro/dollar has been the best performing pair in the G10 FX space so far this year, up more than 10 percent, but market watchers had been wary of pushing the single currency higher before the policy decision was released on Thursday.

Concerns that the currency’s strength would translate into a tightening of euro zone financial conditions – something policymakers have been wary about as they seek to protect an economic recovery – had prompted traders to take large bets on euro weakness in recent days, betting the rally wouldn’t last.

European Central Bank President Mario Draghi said on Thursday that financing conditions remained broadly supportive, and noted that the euro’s appreciation had “received some attention.” However, he did not cite that as a problem nor did he directly try to talk the currency down.

Strategists at Bank of America Merrill Lynch said that by avoiding any direct statements on the euro’s level, “Draghi has effectively removed the acceptable euro ceiling for the ECB.”

“Further EUR appreciation could become easier, as the ECB seems to have given up trying to control the currency,” they said in a daily note.

The euro’s 0.3 percent vault above $1.1650 in early trading on Friday meant that those holding currency options betting on a fall in the single currency after the European Central Bank’s meeting on Thursday faced heavy losses.

It was up 0.2 percent at $1.16495 in midday trades.

Of the 65 forecasts for the single currency before the ECB decision, only one – HSBC – was prepared to predict the euro would reach $1.20 this year.

Now that level may be just a matter of time, according to some strategists.

“If you look at the euro’s strength through the prism of euro zone financial conditions, they still remain very accommodative and a test of the 1.20 line is on the cards though that may be taking it near the ECB’s danger zone for tolerance,” said Viraj Patel, an FX strategist at ING in London.

Borrowing costs in the euro zone for households and companies remain near record lows according to official data, though the euro’s rise would have offset some of those easy borrowing conditions.

Notwithstanding the recent bounce in the single currency, analysts at Deutsche Bank say the euro still remains about 15 percent undervalued against the dollar on a purchasing parity basis, so there is more room for the euro to gain.

The next target level for the euro was an August 2015 high at $1.17150, according to strategists.

The euro’s strength pushed the dollar to an 11-month low of 94.089 against a trade-weighted basket of other major currencies. (Reporting by Saikat Chatterjee)

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