LONDON: The euro was under pressure on Wednesday, losing ground against the dollar and the Swiss franc, as peripheral euro zone debt worries and risks of a contagion returned to investors' radar after Moody's slashed Portugal's credit rating to junk.
Still, many expect losses to be checked as the market gears up for a quarter percentage point rate hike by the European Central Bank on Thursday. Add to that, the United States' own struggles with its budget deficit and wrangling over ways to raise the debt ceiling are likely to weigh on the dollar.
The euro was down 0.4 percent at $1.4370 as investors sold the single currency after spreads of Portuguese, Spanish and Italian government bond yields over their German counterparts widened in European trade.
Heightened concerns about funding concerns in Portugal are likely to drive investors to sell the euro, which has near-term support at $1.4330-- the 38.2 percent Fibonacci retracement of the its fall from a high of $1.4940 on May 4 to a low of around $1.3970 on May 23.
"Greece is a basket case and we will probably have Portugal and Ireland drifting in the same boat," said Steve Barrow, head of G10 currency research at Standard Bank. "But for the ECB raising rates, we would have the euro falling pretty sharply. It is likely to hold in the $1.40-$1.50 range for now."
Moody's cut Portugal's credit rating by four notches to Ba2, saying there is great risk the country will need a second round of official financing before it can return to capital markets.
Despite the downgrade, the single currency was lifted by stop-loss buying as well as broad weakness in the dollar in the Asian session. The dollar fell prey to profit taking after Tuesday's short squeeze with Asian central banks selling it while hedge funds liquidated their bullish bets in dollar/yen.
Traders said that while a quarter percentage point rate hike by the ECB was mostly priced in, the euro's near-term outlook would depend on whether ECB President Jean-Claude Trichet sounds hawkish or not on Thursday.
Analysts said the euro could have a hard time eking out more long-term gains versus the greenback if Friday's US payrolls data suggests the US economy is not doing as badly as feared and with yields on 10-year US Treasuries firmly above 3 percent.
These views were echoed by Minoru Shioiri, forex manager at Mitsubishi UFJ Morgan Stanley Securities in Tokyo.
"The moves in euro/dollar will likely be determined by news on the US side rather than by the possible rate hike by the ECB -- if payrolls are strong, we may see the euro edging towards $1.40 long term," said Shioiri.
SAFE-HAVEN SWISSIE SHINES
Underscoring investors' nervousness ahead of the ECB meeting and US payrolls, the euro lost ground against the Swiss franc, shedding 0.3 percent to trade at 1.2091 francs . Traders said the break of support around 1.2180 francs triggered more selling in a move that unwound about a third of last week's 4.3 percent rally.
The Swiss franc had risen to record highs against the euro and the dollar late last month as edgy investors sought the safe-haven currency amid worries about a Greek default and a possible global slowdown.
While Portugal's downgrade reignited lingering fears about other highly indebted peripheral euro zone countries, a broad flight from risk was averted with stocks and commodities advancing and the Australian and New Zealand dollars holding steady.
The dollar softened versus the yen, shedding 0.2 percent to trade at 80.93 yen, as hedge funds liquidated some of their longs and exporters sold.
The pair continued to frustrate dealers as it kept trading within the well-trodden range roughly between 79.80 and 81.30.
Meanwhile, commodity currencies like the Australian dollar held up pretty well despite Portugal's downgrade. Talk of bids from Asian central banks and local exporters around $1.0660/70 for the Aussie appeared to be providing a floor.
The Aussie was flat at $1.0695 , off Tuesday's session low around $1.0664. It came under pressure in the previous session following less upbeat comments from the Reserve Bank of Australia.
Copyright Reuters, 2011
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