Euro little changed but vulnerable as markets wind down

NEW YORK: The euro was little changed against the dollar on Friday, with further declines likely heading into the new year as the festering euro zone debt crisis spurs investors to shun risk.

A rise in new single-family homes to a seven-month high in November reported on Friday came on the heels of other signs of improvement in the US economy on Friday and added to the dollar's allure at the euro's expense. Optimism on the US economic recovery stands in sharp contrast to the doom felt in Europe as monetary and political authorities struggle to resolve the sovereign debt crisis and hold the euro zone together.

The data on home sales came a day after another promising report on initial jobless claims. Jobs and housing growth have been the two missing ingredients of the US economic recovery.

For the week, the last full week of trading for the euro, the euro was little changed, after two prior weeks of declines.

"Three back-to-back weekly jobless claims reports showing improvements in the US, but in Europe, unfortunately, we are not quite seeing that," said Greg Salvaggio, vice president of currency trading at Tempus Consulting in Washington. "The theme next year is euro down, euro down, euro down."

The single currency was last at $1.3044, holding above a recent 11-month low. It is down around 2.5 percent on the year.

Traders highlighted some stop-loss orders in the $1.3120 region, which if hit could push the euro higher in thin markets. The session peak posted at $1.3095.

SOVEREIGN THREAT

But with the threat of sovereign downgrades hanging over the bulk of the euro zone, sentiment toward the single currency remained bearish heading into the new year, with the liquid dollar likely to be supported.

Two independent European government sources told Reuters on Friday that Standard & Poor's is not expected to release its much-awaited verdict on debt ratings for 15 euro zone countries until January. S&P early this month warned that it might issue a mass downgrade on ratings of the 15 countries.

Doubts over the effectiveness of this week's huge European Central Bank tender of cheap loans in easing the strain for troubled euro zone economies are likely to keep peripheral sovereign bonds under pressure.

Italian bonds in particular are expected to come under renewed strain as the country faces a major refinancing hurdle early in the new year.

Many market participants say heavy buying of Italian and Spanish debt by the ECB is required to ease concerns over the precarious finances of the two countries.

A departing member of the ECB Executive Board, Lorenzo Bini Smaghi, said on Thursday the ECB was able to scale up its actions if needed and said quantitative easing could be an option.

"The lower-than-desired growth rates in broad money and credit and the downside risks to price stability will likely be the catalyst in driving the ECB to increase its bond buying program early next year and will be presented as a way to counteract them," BNP Paribas said in a note.

BNP recommended selling into any year-end rally for the euro and highlighted the $1.32-1.3250 area as tough resistance.

LOW EXPECTATIONS

Morgan Stanley analysts expect the euro to be among the worst-performing G10 currencies next year due to the deteriorating economic outlook in Europe, continued ECB easing and liquidity measures, along with portfolio outflows.

A break below $1.2945 in the euro would open up a test of the 2011 trough, traders said.

The euro was hovering near all-time lows against the Australian dollar on diverging economic fundamentals between Europe and Australia. Analysts expected the euro to continue to lag the risk-sensitive Aussie should asset markets rally in 2012.

Against the safe-haven Swiss franc, the euro was up 0.1 percent at 1.2225 francs, not far from the cap of 1.20 introduced by the Swiss National Bank in September.

The US currency stayed supported at 78.11 against the yen .

Copyright Reuters, 2011