Euro slumps to 11-month low vs dollar on EU pessimism

LONDON: The euro slumped to an 11-month low against the dollar on Wednesday, as investors speculated that more euro zone countries may be downgraded in the near term given that a quick solution to the region's debt crisis remains elusive.

Market participants also drove the single currency lower against the yen and sterling ahead of an Italian bond auction later in the day.

Poor demand at the sale may send 10-year Italian bond yields towards lifetime highs, after they have already climbed above 7.0 percent a level considered to be unsustainable.

The euro fell as low as $1.3005, its weakest since early January. Investors dumped the single currency for the safety of the dollar, which jumped to its highest level since January versus a currency basket.

The euro quickly bounced back to around $1.3040, after a further fall was cushioned by hefty bids from an Asian sovereign name, according to traders. More bids were seen around the psychologically key $1.30 level and below.

Market participants also cited hedging-related demand from European corporates as preventing more losses, but analysts argued the single currency may take a further pummeling if investors become more pessimistic about the euro zone's health.

"There's definitely strong support around $1.30, and also in the $1.30-1.29 region," said Arne Lohmann Rasmussen, chief analyst at Danske in Copenhagen.

"But if we get a further deterioration of the euro zone debt crisis, if we see a lot of countries being downgraded, or more problems in the banking sector, this $1.30 is not going to hold."

Markets were braced for a possible mass downgrade of euro zone countries, which would deepen the region's debt crisis, after last week's key summit offered no hopes for an immediate resolution.

Speculation is rife that a downgrade for France could come any day.

The single currency fell to 101.44 yen, its weakest since early October, while hitting a nine-month low of 83.92 pence.

Market participants said a fall below $1.30 in euro/dollar may increase its downward momentum due to options-related selling.

"If we do go below, options players are again likely to exacerbate the move as they scramble to cover lost gamma," Citi analysts said in a Citi FXWire note.

But they added: "More options barriers are reported at $1.2950 and in size at $1.2900. The 2011 low at 1.2855 offers key support below there."

The dollar index, which tracks the dollar's value against a currency basket, rose as high as 80.407.

Investors picked up the US currency, considered a safe haven given its vast liquidity, after the Federal Reserve on Tuesday warned that turmoil in Europe posed a big risk to the US economy.

The US central bank refrained from boosting its easing measures this month, as expected.

Copyright Reuters, 2011

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?P Bank of Tokyo Mitsubishi UFJ, said the pound and gilts were benefiting from the Bank of England's asset purchase programme which sets it on course to hold around 30-40 percent of outstanding debt.

"In the long run, the risk of higher inflation in the UK may eventually prove pound-negative but in the near term having the central bank stand behind the domestic debt market is providing a source of stability," he said.

His bank expects the euro to fall to 82 cents in six months and to 80 pence in 12 months.

Audrey Childe-Freeman, EMEA head of currency strategy at JPMorgan Private Bank, said the UK's isolation over the proposed treaty was not a huge problem in the short run.

"It is probably positive in the short term because the market doesn't trust the euro zone and being as far away as possible from those issues is good," she said. "If the euro eventually gets out of its current predicament, then being isolated would be negative for the UK."

Sterling is also likely to struggle against the dollar as the prospects of more quantitative easing by the Bank of England weigh along with the country's links and banking sector's exposure to the euro zone.

Almost 50 percent of UK's exports are to the euro zone and UK banks holdings in Greece, Portugal, Italy, Spain and Ireland amount to more than 15 percent of UK's GDP.

All of which is likely to drive investors to seek the relative safety of the dollar if the euro zone crisis worsens. Sterling traded at $1.5540 on Tuesday, almost flat on the year.

"US data is showing signs of improving while people will be worried about UK's exposure to the euro zone," RWC Capital's Frost said. "Some are expecting it to fall to $1.51."

Copyright Reuters, 2011