Euro pares gains; German vote relief rally fades

LONDON: The euro retreated from highs against the dollar on Thursday after support from German approval for boosting the euro zone rescue fund gave way to selling given that policymakers still lack a cohesive plan to solve the region's debt crisis.

German Chancellor Angela Merkel's coalition party voted to enhance the Euro Zone Financial Stability Fund's powers, joining 10 other countries that have approved an expansion that would increase the euro zone's firepower to help debt-ridden countries.

The other six will vote in coming weeks.

The euro traded 0.5 percent higher on the day at $1.3620, still well a above an eight-month low of $1.3360 hit earlier this week.

It retreated from a session high of $1.3679 hit in the lead-up to the vote, and traders said the euro's early rally lost steam ahead of big offers suspected around $1.3680-1.3700.

Analysts said that while investors were relieved Berlin had passed the EFSF bill, they were wary of pushing the euro higher until euro zone officials have a credible plan to prevent Greece's debt problems from spreading to other countries.

"Beyond this vote nothing has changed and we're awaiting a more comprehensive response from euro zone policymakers," said Lee Hardman, currency analyst at BTM-UFJ.

"The relief rally in the euro over the past week has been built on unsustainable foundations."

The euro was also supported on optimism that the next tranche of Greece's bailout funds will be approved, while there was speculation of month-end demand from fund managers, who many believed would rebalance their portfolios by buying euros following its steep sell-off this month.

Meanwhile, talk of Asian sovereign supply in the $1.3700 zone was seen capping any significant gains.

"I'm pretty flat (on my euro position) to be honest," said a trader in London, who had bought the euro earlier in the day, only to sell it back following the vote announcement.

"I'm not sure where we go from here (on the debt crisis) but I think the path of least resistance is still lower with any rallies likely to be sold."

On the downside, traders reported demand from model-based accounts around $1.3580 with stop-loss orders below.

The euro remains short of $1.3715, a key resistance level that is a 61.8 percent retracement of its decline to $1.3360 from $1.3937. Support is at $1.3475-85, a 61.8 percent retracement of its advance to $1.3360 from $1.3690.

The single currency was still on track to mark its worst quarter since early 2010, with traders wary over potential for further falls, on nagging worries over the prospect of Greek default and constant bickering by European policymakers.

This in turn has sparked jitters over contagion to Italy and Spain and fuelled fears about the sovereign debt exposure of European banks.

The yield on Italy's 10-year bond rose to a new euro lifetime high of 5.86 percent at an auction on Thursday, as jitters about the country's public debt pile pushed its borrowing costs higher.

BERNANKE'S INFLATION CAUTION

The euro rose 0.7 percent against the yen to 104.30 yen , having bounced from a decade low of 101.90 yen earlier in the week. Tokyo exporters have been spotted selling in transactions related to the end of the quarter, but traders said the majority of them were likely settled by now.

The dollar rose 0.2 percent on the day to 76.65 yen, not far from the record low of 75.94 hit in August.

The dollar index nudged 0.2 percent lower to 77.644, off an eight-month peak of 78.863 struck on Monday, with some analysts saying its recent safe-haven strength may be undermined by expectations of more stimulus from the Federal Reserve.

In a market fixated on the euro zone debt saga, comments by Fed chairman Ben Bernanke on Wednesday that the US central bank may act if inflation falls further drew hardly any attention.

But the comments appeared important as inflation expectations are already very low. The gap between yields on 10-year Treasury notes and their inflation-protected counterparts fell to 1.70 percent last week, the lowest since September 2010.

Copyright Reuters, 2011