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The euro rallied on Tuesday after a Reuters story that European Central Bank policymakers will discuss whether to raise interest rates by 25 or 50 points at their meeting on Thursday to tame record-high inflation.

The jump in the euro, which sent it further away from the sub-parity levels of last week, coincided with falling expectations for an aggressive 100 basis point hike from the Federal Reserve this month, which knocked the dollar.

The euro rose to as high as $1.0259, up 1.2% on the day and its strongest since July 6 as money markets priced in a 60% chance of a 50 basis point hike on Thursday, up from 25% on Monday.

The dollar index dropped 0.9% to 106.47, well back from the high of 109.29 last week, a level not seen since September 2002.

Analysts are reluctant to turn bullish on the euro, however, given ongoing concerns about supplies of natural gas and the hit to its economy and how hawlish the ECB can really be.

"In our view, this bounce is likely to prove short-lived and should provide better entry levels for short euro positions," said Dominic Bunning, Head of European FX Research at HSBC.

"Even if the ECB does deliver a 50bp hike, the positive follow through for the euro may be limited," he added, noting that 50 basis points "no longer looks so hawkish" against bigger hikes from the likes of the Fed and the Bank of Canada and that close to 150 bps of ECB hikes in 2022 were already priced in.

GRAPHIC: Euro positions and volatility https://fingfx.thomsonreuters.com/gfx/mkt/zgpomxangpd/euro%20positions%20and%20vol.JPG

Traders are also preparing to see if Russian gas on Thursday resumes flowing through the Nord Stream pipe to Germany after a shutdown for scheduled maintenance.

Russia's Gazprom, which operates the pipeline, has told customers in Europe it cannot guarantee gas supplies because of "extraordinary" circumstances, according to a letter seen by Reuters, upping the ante in an economic tit-for-tat with the West.

Elsewhere the Australian dollar soared 1.3% to $0.6903 after Reserve Bank of Australia policymakers said they saw the need for more policy tightening on top of recent hikes.

"The RBA board has lifted the intensity of its rhetoric," Westpac economist Bill Evans wrote in a research note. "Another 50 basis points in August seems highly likely."

The Japanese yen rose to 137.57 yen per dollar but was not far from a 24-year low ahead of a Bank of Japan policy decision on Thursday. The central bank has committed repeatedly in recent days to continue ultra-easy settings.

Sterling gained 0.7% to $1.2027, tracking the wider rebound against the dollar.