NEW YORK: The euro fell against the US dollar on Friday after a downgrade to Spain's credit rating and signs of economic weakness in Italy and Germany, leaving the single currency vulnerable as euro zone risks increased.
Despite Friday's losses, the euro posted its best weekly performance since April, notching gains after five straight weeks of declines. Analysts, however, were convinced gains would be short-lived as investors sought to square up ahead of the weekend.
European Union and German sources told Reuters Spain was expected to ask for an aid package over the weekend to prop up its troubled banks.
Rating agency Fitch slashed Spain's credit rating on Thursday, leaving it just two notches above junk status. It signaled further downgrades could come as the country tries to restructure its troubled banking system.
"We have come to the edge of the cliff. There are so many issues in Europe now," said Simon Smollett, senior currency options strategist at Credit Agricole in London. "We're all waiting for the Greek elections and when that's over, we have Spain."
Last month's Greek election resulted in no party achieving the 50 percent threshold needed to achieve a majority. Greece was unable to form a coalition government, setting up the next round of elections on June 17.
A victory for anti-bailout parties would raise the possibility of Greece leaving the currency union.
The euro was last down 0.4 percent at $1.2508, retreating from a two-week high of $1.2625 hit on Thursday after a surprise interest rate cut by the Chinese central bank.
More losses would leave the euro vulnerable to a test of the 23-month low of $1.2286 hit on June 1, based on Reuters data, after failing to break above chart resistance at $1.2623, the January low.
The euro also took a hit after Italian industrial production fell far more than expected in April and German imports tumbled at their fastest rate in two years, adding to euro zone recession concerns.
But the common currency came off its lows after China said it would cut fuel prices by nearly 6 percent from Saturday, which some traders saw as another positive step that may help stimulate China's economy.
Net short positioning on the euro hit another record high, according to data from the US Commodity Futures Trading Commission, as risk aversion drove the currency market. Exposure to commodity currencies was reduced across the board, with the Australian dollar taking a big hit.
"We are now less confident that the euro zone will continue to muddle through," said global macro hedge fund GLC Ltd in London. "The countries that need to make the biggest adjustment have the weakest economies. In addition, austerity fatigue is spreading."
GLC, which manages assets of about $1 billion, has taken risky trades off the table and even if news out of Europe improves and the euro spikes as a result, it would look to short the currency.
The euro fell 0.7 percent against the yen to 99.36 yen. The safe-haven Japanese currency gained broadly as market sentiment declined, with the dollar losing 0.3 percent to 79.45 yen.
But the euro still posted its best week versus the yen since late February, with a gain of 2.3 percent.
Currencies with more perceived risk initially came under pressure after US Federal Reserve Chairman Ben Bernanke offered no hints of imminent monetary stimulus on Thursday, upsetting some market players who had positioned for a dovish statement.
But by late afternoon, the higher-yielding Australian dollar rose 0.4 percent on the day against the US currency to US$0.9922 as US stocks ended higher, while the New Zealand dollar gained 0.6 percent to US$0.7710.
Thomson Reuters on Friday released its monthly foreign exchange trading volumes for May 2012. May average daily volume was $154 billion, up from $130 billion in April but down from the $161 billion in May, 2011.
ICAP said on Friday that average daily spot FX volumes on the EBS platform, which competes with Thomson Reuters, were $130.8 billion for May.
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