May 30, 2012 / 5:37 AM / 5 years ago

FOREX-Euro drops to 2-year low on Spain's debt woes

* Spanish banking problems overtake worries about Greece

* Focus on rising Spanish debt yields, spreads vs Bunds

* Aussie slips on weak retail sales data

* Dollar index on cusp of closing above 100-month MA

By Masayuki Kitano

SINGAPORE, May 30 (Reuters) - The euro fell to a two-year low on Wednesday, hurt by worries about Spain's soaring borrowing costs and expectations that more spending may be needed to support its ailing banks.

The 10-year Spanish government bond yield hit a six-month high on Tuesday, and the sell-off in Spanish bonds has driven up their risk premium over safe haven German Bunds to euro-era highs this week.

"It's as if everything starts and ends with Spain. Everyone is talking about Spain, putting Greece's problems on the back burner," said Satoshi Okagawa, senior global markets analyst for Sumitomo Mitsui Banking Corporation in Singapore.

"The rise in Spanish-German yield spreads to levels over 5 percentage points is a big factor. The widening in the spread has been significant, and is weighing on the euro against both the dollar and the yen," Okagawa added.

The euro fell to as low as $1.24572 on trading platform EBS, its lowest level since July 2010, nearing rumoured stop-loss offers near $1.2450 that could cause the euro's drop to accelerate.

The single currency was last down 0.3 percent from late U.S. trade on Tuesday at $1.2471.

Against the yen, the euro dipped 0.3 percent to 99.09 yen , nearing a four-month low of 98.942 yen hit on Tuesday.

The euro had gained some reprieve earlier in the week after Greece's pro-bailout parties regained an opinion poll lead ahead of elections on June 17, easing fears of a messy Greece exit from the euro zone.

But the single currency's bounce proved short-lived as the market's focus shifted to Spain, and its failure to breach resistance near $1.2625 this week has left the euro looking vulnerable.

A government source told Reuters on Tuesday that Spain would likely recapitalise Bankia, which asked for 19 billion euros on Friday, by issuing new debt and possibly drawing cash from the bank restructuring fund and Treasury reserves.

Adding to the euro's woes, Egan-Jones Ratings cut Spain's credit rating yet again. Tuesday's move was the small firm's third downgrade of the country's sovereign debt in less than a month.

DOLLAR INDEX

The Australian dollar sagged after weaker-than-expected retail sales data underscored the case for interest rate cuts by the central bank.

The Aussie dollar fell 0.5 percent to $0.9793, slipping back in the direction of a six-month low at $0.9690 hit last week.

Risk aversion on the worries about Europe, coupled with concerns about a slowdown in China -- Australia's main export market -- have knocked the Australian dollar down about 6.1 percent so far in May.

Posing a contrast is the safe-haven dollar, which is on the cusp of generating a bullish signal on longer-term technical charts.

The greenback has risen about 4.8 percent in May against a basket of major currencies and the dollar index is now at 82.572 , above its 100-month moving average near 81.82.

A monthly close above that resistance may herald a shift in the longer term trend of the dollar, some analysts say.

"From a medium-term, long-term perspective, dollar has been on a downtrend over a multi-year period," said Mitul Kotecha, head of global foreign exchange strategy for Credit Agricole in Hong Kong.

"If the dollar does close above that 100-month moving average, that might just suggest a break of this long-term downtrend," Kotecha added.

The yen is another safe haven currency that has done well this month. On Wednesday, the dollar fetched 79.47 yen, not far from a three-month low of 79.002 yen hit earlier in May.

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