By Ritvik Carvalho

LONDON (Reuters) – The euro edged higher before a European Central Bank meeting later on Thursday, where any positive comments about the economic outlook or hints of tapering bond purchases are expected to send the common currency racing higher.

The ECB is not expected to change policy when it meets later on Thursday, but analysts say this meeting will set the stage for June, when policymakers have to decide whether to slow its bond buying. The ECB’s decision is due at 1145 GMT, which will be followed by a press conference at 1230 GMT.

Dutch central banker Klaas Knot has already said tapering is possible, and the euro could resume its rise against the dollar on any signs a reduction in bond purchases is gaining more support within the ECB, analysts said.

“The ECB has already increased the pace of bond purchases at one of the latest meetings, so changes to the current monetary policy look very unlikely at the upcoming meeting,” said Vladimir Potapov, CEO of VTB Capital Investments.

“The economy will likely gather pace in the second half of 2021 amid a better epidemic situation, massive vaccination, and global economic recovery,” Potapov said, noting an acceleration in inflation from February to March.

ECB PEPP https://fingfx.thomsonreuters.com/gfx/mkt/qzjvqzdlopx/Pasted%20image%201619089119287.png

The euro was quoted at $1.2033, up 0.1% on the day and not far from its strongest since March 3. The common currency has gained as much as 3% against the dollar since the start of April.

“We expect the European Central Bank meeting today to have a limited impact on the euro,” said strategists at ING in a research note.

The euro’s gains weighed on the dollar, which eased to 108.03 yen, close to a seven-week low.

The greenback traded near multi-week lows against most major currencies as fading gains in U.S. Treasury yields reduced its interest rate advantage.

Sentiment toward the dollar has weakened as last month’s spike in Treasury yields reverses course, but some analysts say the outlook over the longer term remains positive due to a strong U.S. economy and an improved coronavirus vaccination programme.

The British pound bought $1.3914, down 0.1% on the day.

The onshore yuan rose to 6.4890 per dollar to reach its strongest level since March 12.

On Wednesday a closely watched auction of U.S. 20-year Treasuries drew strong demand, which helped the fixed income market regain its composure and put a cap on yields.

Last month, Treasury yields spiked to their highest in more than a year due to worries about accelerating inflation, which prompted dollar bulls to pile into the currency.

However, this trade has started to unwind this month as yields reversed course, and investors will now look to the U.S. Federal Reserve’s meeting next week for new trading cues.

“Looking ahead, we see a strategically high risk that US real rates will make a comeback from their recent consolidation supported by a recovery in US nominal variables,” said Lars Sparresø Merklin, senior analyst at Danske Bank.

“With euro/dollar at $1.20 and our strategic view on real dollar yields, we see the surprise potential as being pro-U.S., towards a hawkish Fed and stronger USD.”

Monetary policy has drawn renewed attention after the Bank of Canada signalled that it could start raising interest rates in late 2022 after it cut the pace of bond purchases, making it the first Group of Seven central bank to move towards withdrawing stimulus.

The Canadian dollar, which surged to a six-week high on Wednesday, was last quoted at 1.2498 against its U.S. counterpart, flat on the day.

The Australian and New Zealand dollars traded near one-month highs against the U.S. dollar, supported by speculation that their central banks are more likely to follow Canada’s example due to an improving economic outlook.

The Aussie fetched $0.7745 and the Kiwi changed hands at $0.7184.

(Reporting by Ritvik Carvalho; additional reporting by Stanley White in Tokyo; editing by Larry King, William Maclean)