SYDNEY/TOKYO Dec 7 (Reuters) - The euro languished at one-week lows against the dollar on Friday, having suffered a major setback after the European Central Bank painted a bleak outlook for the euro zone and discussed cutting interest rates.
Political turbulence in Italy also hit Italian bonds and added to losses in the euro after Silvio Berlusconi's People of Freedom party withdrew its support for the technocrat government of Prime Minister Mario Monti on Thursday.
"The main trigger for the sharply negative euro reaction was the mention of a 'wide' discussion over rate cuts, while Mr. Draghi also said the ECB was 'operationally ready' for negative rates," said BNP Paribas strategist Vassili Serebriakov.
ECB President Mario Draghi said policymakers talked about cutting its main 0.75 percent policy rate before opting to leave it on hold, even as it slashed forecasts for growth. They also touched on the idea of cutting its deposit rate into negative territory.
The single currency steadied at around $1.2970 in Asia on Friday, after having fallen nearly 1 percent on Thursday, its biggest one-day loss in a month and retreating from a seven-week peak of $1.3127 set mid-week.
An immediate support is seen around $1.2949, a level representing the 38.2 percent retracement of its Nov. 13-Dec. 5 rally.
Against the yen, the euro stood at 107.00 yen, about a full yen below a seven-month high of 107.96 yen hit on Wednesday.
The slid in the euro helped push the dollar index up to 80.236, rebounding from a six-week trough plumbed mid-week of 79.568.
Selling has subsided in Asia as traders look to the U.S. non-farm payrolls report due 1330 GMT. Analysts polled by Reuters expect a sharp slowdown in employment growth due to the disruption caused by superstorm Sandy.
Payrolls likely rose only 93,000 last month after advancing 171,000 in October, according to a Reuters survey of economists. The unemployment rate is seen holding steady at 7.9 percent.
Any weakness in the closely watched report would also reinforce expectations that the Federal Reserve will announce a new round of Treasury bond purchases to replace its expiring Operation Twist programme at next week's meeting.
Such action could keep investors from getting too enthusiastic about the dollar.
The dollar also held almost flat against the yen at 82.50 yen, stuck in a triangle holding pattern after having hit a 7-1/2-month high of 82.84 yen last month on expectations of a more aggressive easing by the Bank of Japan.
Selling related to hedging for an option barrier at 83 yen is capping the dollar for now, but some traders see the chance of a break there after the U.S. jobs data.
"Even if the payrolls data is weak, if the dollar's support below 82 yen will be confirmed, then the dollar could test this year's high above 84 yen next week," said Hiroshi Maeba, head of FX trading Japan for UBS in Tokyo.
Meanwhile, the Australian dollar showed little sign of backing down after a surprisingly firm employment report on Thursday prompted markets to trim chances of an interest rate cut at the Reserve Bank of Australia's next meeting in February.
The Aussie reached $1.0515 on Thursday, a high not seen since September, before profit-taking took it down a notch to $1.0478. Its resilience is remarkable given this week's interest rate cut and a slew of data pointing to a less rosy outlook for the local economy.
It last stood at $1.0480, almost flat from late U.S. levels.
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