May 30, 2017 / 11:51 AM / 4 months ago

FOREX-Dollar, yen inch higher as European political nerves weigh

(Updates prices)

* Euro undermined by signs of early elections in Italy

* ECB chief Draghi points to need for continued stimulus

* Greece nerves also weighing

* Sterling recovers after worst week since February

* Graphic: World FX rates in 2017 tmsnrt.rs/2egbfVh

By Patrick Graham

LONDON, May 30 (Reuters) - Political worries over Greece, Italy and Britain had European currencies on the retreat against the dollar on Tuesday, with a bleaker mood on stock markets also pushing the yen higher.

The dollar index, under pressure over the past fortnight from concerns over the Trump administration’s difficulties, gained around 0.1 percent in morning trade in Europe.

Falls in inflation in Spain and several German regions, as well as European Central Bank chief Mario Draghi’s commitment to continued emergency stimulus on Monday, helped push the euro just over 0.1 percent lower to $1.1149.

But signs that elections in Italy may now come as early as September provided the biggest driver.

“We always knew Italy was going to come back into the market’s sights, but I think people thought we would have a longer stay of execution,” Rabobank currency strategist Jane Foley said.

“It does seem like the market will have to face worries about elections and populism again over the summer. That of course is a drag for the euro.”

Italian banks and blue chip shares fell sharply for a second day before recovering as U.S. and UK investors returned after Monday’s holiday.

Other major markets were also deeply in the red, with French shares sinking almost 1 percent, prodding investors towards the traditional security of the yen, which gained around 0.3 percent against the dollar and 0.4 percent against the euro.

Sterling recovered from some early losses to trade 0.2 percent higher at $1.2868.

Sterling bulls have been unnerved by the shrinking in some polls of Prime Minister Theresa May’s lead to as low as 5-6 percentage points, suggesting the landslide she targeted a month ago may now be out of reach.

Analysts say that will weaken her ability to face down hard line Brexiteers in her Conservative Party. But the prospect of a Labour Party-led government is also creeping onto the agenda.

A left-leaning administration led Jeremy Corbyn might worry debt markets by borrowing and spending more on public finances, but it could also spell a softer Brexit approach.

“The main reason for the falls is that (with a smaller majority) there would be more political infighting. Maybe May would have to listen to the more extreme views on Brexit,” said Commerzbank strategist Thu Lan Nguyen.

“If there really was a good chance that Labour was going to win, I think this could turn around. At this point does Labour have a smarter Brexit plan? I‘m not entirely sure. But at least it would be a softer Brexit.”

For Reuters Live Markets blog on European and UK stock markets see reuters://realtime/verb=Open/url=http://emea1.apps.cp.extranet.thomsonreuters.biz/cms/?pageId=livemarkets (Editing by Andrew Heavens and Alexander Smith)

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