The euro, which had fallen more than 15 per cent since its January debut to a low of $1.0104 last week, could now be pulling free of the lure of parity against the dollar, traders said.

"I'd say put your parity party hats back in the cupboard," said David Bloom, currency strategist at HSBC Markets. "The idea of parity for parity sakes is being wiped out by fundamentals."

The euro jumped more than two cents in less than 24 hours to a peak of $1.0394 by European midday, its highest since June 28.

The rally began in Monday's North American trading on short-covering ahead of Germany's IFO business climate survey, and accelerated in Europe as the IFO's headline West German business climate index came in at 92.9, far exceeding the average forecast of 91.1 and a May reading of 90.4.

Analysts said thewriting had anyway been on the wall for the persistent dollar bulls, noting that yields on European bonds had risen sharply in recent weeks in response to signs of an economic upturn in the euro zone.

"The only thing that had failed to follow until yesterday was the euro, but now it's playing a little bit of catch-up," Bloom said.

Peter von Maydell, senior currency strategist at Credit Suisse First Boston in London, said his study of yield differentials between US Treasuries and German bunds in the past decade showed that currencies always lagged bonds.

"It shows that people had been bearish even though growth expectations in the bond markets have been swinging sharply in favour of the euro and likewise data proving that Europe is recovering," he said. "IFO isn't even news in that respect."

Calculating from the historical relationship between 10-year US T-note and bund yields, a euro/dollar rate between $1.08-$1.10 would be more consistent with growth differentials that debt markets were suggesting,von Maydell projected.

He said other European currencies such as the Swiss franc and the Swedish crown had similar upside potential against the dollar, while sterling was roughly in line with yield levels.

The Swiss franc rallied to its highest levels in three weeks, with dollar/Swiss tumbling to a low of 1.5439 francs from 1.5762/72 in late on Monday in Europe. Sterling/dollar peaked at $1.5818, just short of Monday's $1.5825 three-week high.

The latest rally in the European currencies, however, has yet to convince the sceptics.

The gains were still within a normal correction to a strong prevailing downtrend, said Yuji Tashiro, a dealer at Daiwa Europe Bank in London.

"The market obviously got overextended on the move down to recent lows," he said. "But it doesn't look like we're just going to clear $1.05 straight away. I think the risk is still on the downside."

The dollar was consolidative against the yen after Monday's three-yen selloff, gyrating largely around 118 yen.

The dollar was lasttrading at 118.12/22 against 119.22/27 late in Monday's European trading.

An absence of Bank of Japan intervention allowed yen bulls to push the dollar to a five-week low of 117.68 on Monday, but traders said lingering fear of central bank action kept the US unit from reaching the 117.59 June 10 low, where the BOJ's recent rounds of intervention had begun.

Traders said the market would question the resolve of the Japanese authorities to curb what they have called the premature strength of the yen if the BOJ did not step in when the Tokyo market returned from Tuesday's National holiday.