December 10, 2012 / 12:57 PM / 5 years ago

FOREX-Euro slips, vulnerable to Italian political turmoil

* Euro dips after Monti says will quit once budget passed

* ECB rate cut prospects hurt euro

* Italian turmoil threatens contagion effect on Spain

* Fed meeting on Wednesday significant for dollar

By Anooja Debnath

LONDON, Dec 10 (Reuters) - The euro dipped against the dollar on Monday as political turbulence in Italy stoked concerns about the region's near-term outlook.

The euro was seen susceptible to further losses as the gap between euro zone peripheral bond yields and their German counterparts widened after Italian Prime Minister Mario Monti said on Saturday he would resign once the 2013 budget was passed.

An election in February looks probable, raising questions over who will navigate the euro zone's third-biggest economy out of the debt crisis

The euro was down 0.1 percent on the day at $1.2910, not far from a two-week low of $1.2876 set last Friday. Traders cited stop-loss orders above $1.2920 and near-term support at $1.2842, its 233-day moving average.

The euro posted its biggest weekly losses against the dollar in a month last week, as speculators bet against the single currency on expectations that the European Central Bank will cut interest rates early next year.

"The timing of the Italian news is a surprise and the short term response has been negative for the euro, like we have seen in 10-year Italian bond yields," said Steven Saywell, global head of FX strategy at BNP Paribas.

"There hasn't however been an as dramatic a fall in foreign exchange for now as there has been in the fixed income market," Saywell said, adding that the euro had not moved much from Friday's close and that BNP Paribas would not yet sell the euro.

Ten-year Italian borrowing and default insurance costs jumped on Monday, pushing Spanish 10-year yields higher after Monti's announcement hurt riskier European debt.

While Italy has nearly completed its planned bond market funding for this year, the latest political turmoil could hinder its ability to borrow around 420 billion euros in 2013.

There could also be an impact on neighbouring Spain whose government is studying the need for outside help.

Concerns about core euro zone countries also weighed on the single currency. Germany's Bundesbank last week slashed its growth outlook for Europe's largest economy to 0.4 percent in 2013 from an early estimate of 1.6 percent.

FED FOCUS

Caution about fresh monetary easing steps from the Federal Reserve later this week limited the dollar's advance.

"People are just positioning themselves for the last decent week we could have in terms of data before getting into the Christmas period," said David Bloom, global head of FX research at HSBC. "The Fed meeting will be important."

Many economists expect the Fed to announce on Wednesday monthly bond purchases of $45 billion, signalling it will keep pumping money into the economy to bring down unemployment.

Signs Washington policymakers are no closer to averting tax hikes and spending cuts set to take hold next year, which analysts say could push the U.S. economy back into recession, also weighed on the dollar.

The greenback fell 0.2 percent on the day to 82.25 yen as traders said macro funds cut long dollar positions.

Data showed speculators' net yen short positions last week rose to their highest since mid-2007. With short bets already stretched, traders said it would be difficult for the dollar to advance against the Japanese currency.

But some saw a drop in the dollar as a buying opportunity.

Morgan Stanley recommended buying dollars at 82.00 yen, with a stop of 81.50 yen and a target of 84.00 yen.

The bank expected a weaker yen on the prospect of further monetary easing by the Bank of Japan after a general election next Sunday.

The opposition Liberal Democratic Party is expected to win and this is likely to see more pressure on the BOJ to ease policy.

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