Euro drops as focus shifts to Italy, Swissie slides

LONDON: The euro dipped on Monday as optimism about a Greek coalition government deal faded and focus shifted to Italy, while the Swiss franc came under fresh pressure on mounting speculation that policymakers will take more action to curb its strength.

The Swiss franc tumbled against the euro and the dollar after Swiss National Bank chairman Phillip Hildebrand indicated franc was still highly valued against the single currency. That revived speculation the SNB may lift the floor on the euro/Swiss exchange rate, currently at 1.20 francs.

Analysts said the franc's recent gains had been driven more by developments in the euro zone and Swiss policymakers would have to take that into consideration before deciding to raise the floor in the short term.

Investors continued to take a pessimistic view about the euro zone with markets now concerned that sovereign debt problems would engulf Italy--the region's third largest economy.

Italian/German 10-year government bond yield spread hit its widest levels since 1997 on Monday, a day before Prime Minister Silvio Berlusconi faces a no-confidence vote.

"The euro is under pressure as Italian spreads are up and that is a real risk factor," said Jeremy Stretch head of currency strategy at CIBC World Markets. "Italy is too-big-to- be-safe and markets are fearful that political uncertainty will claim its second victim in Italy."

The euro was last down 0.65 percent on the day at $1.3704, having risen to a high of $1.3839 in the Asian session. Traders cited talk of momentum stops at $1.3670/80 with bids said to be lurking around $1.3660.

In a sign that markets already see more problems for the euro, option traders said there was some interest in longer-dated euro put options. In addition, one-month risk reversals were still not far from a record high in favour of bets on euro falls versus the dollar.

ITALIAN CLIFFHANGER

Greek bank shares jumped on Monday after the country's main political parties clinched a deal, but any relief from that to other asset classes was short lived as focus switched to Italy, the next potential flash point for the market.

Italy poses a far graver risk to the 17-nation currency bloc than Greece. With its borrowing costs soaring and 1.9 trillion euros in public debt, it is too large to bail out.

Berlusconi is scrambling to get support at a parliamentary vote on Tuesday over public finances, seen as a test of his political strength following a humiliating G20 summit where Italy agreed to the International Monetary Fund's monitoring of promised reforms.

Morgan Stanley in a trading recommendation said they expect a renewed move down in the euro targeting the $1.3365 area and then the $1.3100 area last seen in the beginning of October.

It added that the Eurogroup and the Ecofin meetings this week will be important while real activity data would needed to be watched for more weakness. "We have lowered our recommended entry level for euro/dollar short positions to $1.3760."

Despite the bearish outlook, the common currency jumped against the Swiss franc. It was up 1.4 percent on the day at 1.2371 francs . The dollar was up more than 2 percent on the day at 0.9024 francs , rising to its highest level in more than two weeks.

The dollar index was up 0.4 percent at 77.282. Against the yen, the dollar was a tad lower at 78.10 yen.

Reuters sources said trading evidence showed the central bank probably continued to intervene, albeit in small amounts, since Monday when Japan spent a daily record of some 7.7 trillion yen to curb the yen's strength.

Copyright Reuters, 2011