London

THE euro rose on Tuesday before a meeting of the European Commission on Italy's budget that could see Brussels take the unprecedented step of rejecting it and demanding changes.

The dispute over Italy's spending plans and doubts about the leadership of Britain's prime minister who is mired in a stalemate over Brexit, means investors are focusing on the likelihood of further political turmoil in Europe.

Broad risk aversion pervaded currency markets on Tuesday, with the safe-haven Japanese yen and Swiss franc strengthening. Higher-yielding currencies like the Australian and New Zealand dollars fell.

Worries about Italy's spending has bred some doubt about the European Central Bank's plan to raise interest rates next summer and that has hurt the euro. But on Tuesday, it rose 0.2 per cent to US$1.1486.

Italy's bond yields fell on Tuesday before the EC's meeting.

"The prospect of a normalisation of monetary policy was the main reason why the euro was able to appreciate over the past year. But there is a rising risk that this support is now going to crumble," said Commerzbank analyst Thu Lan Nguyen.

Tensions are likely to rise further between Rome and Brussels, especially if the European Council launch an Excessive Deficit Procedure against Italy, said Philip Wee, currency strategist at DBS. "This would require Italy to provide a plan of corrective action to rein in its large public debt."

The dollar index, a gauge of its value against six other major currencies, fell 0.2 per cent after earlier reaching a two-month high of 96.158.

Turbulence in Europe has lifted the dollar recently along with expectations that a strong US economy may see the Fed raise rates faster than assumed.

Britain's pound traded up 0.2 per cent at US$1.30 after falling on Monday on fears that the Irish border issue and disagreements within Britain's ruling Conservatives over Brexit could see Prime Minister Theresa May face a serious leadership challenge.

"Whispers of a growing number of Tory MP rebels losing their patience with May have put the risks of a lengthy UK political impasse and a Brexit policy mistake (exiting the EU without a deal) back on the table," said Viraj Patel, a currency strategist at ING.

"We think this noise is likely to keep the pound on the back foot this week." REUTERS