NEW YORK: The euro plunged to a one-month low against the dollar on Wednesday as Italian borrowing costs topped 7 percent, raising fears the euro zone's third-largest economy would need emergency aid to finance its debt.
The currency fell below $1.36 to its lowest since Oct. 11 and was last down 1.8 percent at $1.3585.
Political turmoil in Italy has thrust it to the epicenter of the worsening euro zone debt crisis this week as markets fret about its ability to adopt reforms to cut its debt burden and make its economy more competitive.
Even with Prime Minister Silvio Berlusconi promising to step down, bond yields continued to rise, prompting Paris-based clearing house LCH.Clearnet to raise margin requirements for Italian government debt used as collateral.
Similar moves preceded bailouts for Portugal and Ireland.
"We're in crisis mode because people don't have confidence that Italy can adopt the austerity measures and reforms needed to make the economy more productive," said Mark McCormick, a strategist at Brown Brothers Harriman in New York.
Higher yields will increase pressure on the European Central Bank to do more. Traders said the bank bought Italian debt aggressively on Wednesday, and McCormick said it may be forced to increase those purchases or to cut interest rates again next month, all of which should weigh on the euro.
The ECB cut rates to 1.25 percent last week.
"All of this is adding to the case for more economic weakness in the euro zone as a whole, and recent manufacturing data suggests things are getting worse," McCormick said.
The euro also fell 1.8 percent at 105.55 yen.
Traders said Japanese investors have in the past been big buyers of Italian debt and the decision to raise margins could see many unwind those positions, adding to the euro's woes.
The dollar was unchanged at 77.70 yen but was up 1.1 percent at 0.9049 Swiss francs.
The euro "looks incredibly vulnerable at the moment," said Chris Turner, head of foreign exchange strategy at ING. "Everyone has concluded that the only buyer of Italian debt is the ECB ... You need a much larger risk premium in the euro and it's not clear where this is going to end."
"We think the euro will drift lower to $1.35 in the near term," said Stuart Frost, head of absolute returns and currency at RWC Partners.
Copyright Reuters, 2011
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