FOREX-Euro rally halts as political uncertainty, data weigh

Tue Feb 5, 2013 12:21am IST

* Euro falls on political worries, Spain data

* Euro investors cautious before ECB meeting

* Dollar rises to fresh 2-1/2-year high against yen

* Expectations of more easing keep pressure on yen

By Julie Haviv

NEW YORK, Feb 4 (Reuters) - The euro slumped from recent highs against the dollar and yen on Monday as political uncertainty in Spain and Italy renewed concerns about the region's debt crisis just days before a European Central Bank meeting.

After rising for four straight days against the dollar and hitting its loftiest level since late 2011 on Friday, the euro succumbed to selling pressure, partly stemming from weak Spanish unemployment data and a smaller-than-expected improvement in a euro zone investor sentiment index.

The data served as a reminder that despite recent reports showing the worst of the euro zone's recession may be behind it, its recovery is far from being solidified.

Spanish 10-year bond yields climbed to six-week highs after Prime Minister Mariano Rajoy faced calls to resign over a corruption scandal involving allegations in the media that he received payments from a slush fund. Rajoy denies any wrongdoing.

Further adding to euro bearishness was news of a probe of alleged misconduct involving an Italian bank that was expected to widen three weeks before a national election. Polls showing Italy's former prime minister, Silvio Berlusconi, regaining ground before elections due this month added to investor concerns.

Italy and Spain are the euro zone's third- and fourth-largest economies, receptively. German Chancellor Angela Merkel told Spain's Rajoy she had full confidence in his government's ability to push through reforms needed to overcome his country's economic crisis.

"The political uncertainties surrounding the region may further dampen the appeal of the single currency as the governments operating under the single currency struggle to get their house in order," said David Song, currency analyst at DailyFX in New York.

The euro last traded down 0.8 percent at $1.3534 after hitting a session low of $1.3521, the lowest since Jan. 30. The euro had risen to $1.3711 on Friday, a level unseen since late 2011.

Against the yen, the euro was last down 1.1 percent at 125.34 yen, off a 33-month high of 126.96 yen struck last week.

The underlying euro zone economic performance remains weak, which does not naturally lend itself to a sizeable build-up in euro long positions, according to Nick Bennenbroek, head of currency strategy at Wells Fargo in New York.

"As a result we still expect the euro to soften over time, although it will probably take a relapse in the economic data or a return to dovish central bank rhetoric for such a decline to occur," he said.

"We see the euro as little changed at $1.35 in three months, and gradually sliding to $1.28 in twelve months," he said. "As a result, we still view the euro's current levels as a selling opportunity."

Nevertheless, the euro remains up 2.6 percent against the dollar so far this year and it could continue to climb should the European Central Bank express no concern about the currency's recent gains at a news conference after its interest rate decision on Thursday.

Monetary stimulus or balance sheet expansion usually hurts a currency as it increases its supply.

"Once the ECB fails to cut rates on Thursday, which is our view, the euro will be free to move higher again, but with the uncertainty surrounding the meeting the euro will likely weaken slightly or trade sideways," said Adam Myers, senior FX strategist at Credit Agricole in London.

YEN WEAKNESS

The dollar touched a fresh 2-1/2-year high of 93.18 yen, but last traded down 0.3 percent on the day at 92.48 yen, according to Reuters data.

"The yen will remain weak, though it will likely not be sold at the momentum seen last week," said Myers, who added that investors would be looking to buy the euro and dollar against the yen on dips.

Sentiment towards the yen is negative as the BOJ is expected to remain under pressure to ease monetary policy aggressively.

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