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Mon 12 Dec 2011 05:10 PM

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Euro falls on concerns debt crisis will intensify

Disappointed investors renew selling of Italian and other government bonds after summit

Euro falls on concerns debt crisis will intensify
Morgan Stanley strategists recommend re-establishing a long dollar/Swiss position

The euro fell on Monday and it looked likely to stay under pressure as disappointed investors renewed selling of Italian and other government bonds after a summit aimed at ending two years of crisis in the euro zone.       

European Union states barring Britain decided on Friday to set stricter budget rules for the single currency area and to provide up to €200bn ($265bn) in bilateral loans to the International Monetary Fund in response to the turmoil.

But uncertainty about the drawn-out process of implementing changes, a lack of emphatic action on cash-starved European banks and the absence of a commitment from the European Central Bank to step up purchases of highly indebted countries' bonds put the euro back under pressure.

It fell around 0.9 percent on the day to $1.3252 on trading platform EBS after triggering stop-loss orders placed under Friday's low of $1.3280, as peripheral bond spreads over German benchmarks widened and equity markets fell. 

Traders reported option-related demand placed ahead of $1.3250 and further stop-losses lurking below there.    

The euro is now more than 6 percent below its October peak and 11 percent off its 2011 high of just under $1.50, struck in early May.

"There is a deflated feeling for the euro this morning after the EU summit. People were looking for a greater response and more importantly the ECB refused to significantly step up their bond buying," said UBS currency strategist Beat Siegenthaler.

"If euro zone bonds come back under pressure there isn't much of a backstop to support the markets," he added.

The ECB was seen buying short-dated Italian bonds on Monday but it was not sufficient to convince markets that the central bank is about to significantly step up its purchases beyond a reported weekly commitment of up to €20bn.

Traders were closely watching the bond yields of Spain and Italy as those countries look to raise an estimated €7bn through bond sales this week.

The euro was put under added strain late in the Asian session when rating agency Moody's said euro area sovereigns would remain under pressure in the absence of decisive initiatives, with the cohesion of the zone under continued threat. 

"We expect the euro to head lower as nothing material has come out of the ECB or the EU summit to change the short-term dynamics and the debt crisis is likely to intensify," said Lee Hardman, currency strategist at BTM-UFJ.

Markets were also waiting for a response from Standard & Poor's which, right before Friday's EU summit, warned it may carry out a credit downgrade of euro zone countries en masse if they fail to move decisively to stem the crisis.

The euro remained tethered in the $1.3200-$1.3500 band it has moved in since late November while IMM data showed only a small reduction in the speculative short euro base, raising the potential for a short-covering corrective rally.

However, any rebound was most likely to provide better levels to sell the common currency, and on the downside traders said a test of the November low at $1.3210 and then the October trough of $1.3145 was likely.  

While bilateral loans to the IMF will beef up the lender's resources to help struggling states, the size of the euro area's bailout fund was still seen as insufficient to safeguard its core economies from contagion from the crisis. 

Moreover, analysts said that even if bond yields stabilise, Europe is probably heading for a recession, with purchasing manager surveys to be released this week expected to point to contraction in the region's manufacturing and service sectors.

With the euro on the defensive, the dollar index rose 0.7 percent to 79.158, and the greenback was up 0.6 percent against the Swiss franc at 0.9302.

Morgan Stanley strategists recommended re-establishing a long dollar/Swiss position, and said although they did not expect the Swiss National Bank to raise the floor they have put on euro/Swiss at a meeting this week, market speculation of such an event would broadly weaken the franc.

Higher-yielding currencies such as the Australian dollar fell back with equity markets under pressure.

The Aussie was down 1 percent on the day at $1.0100 with technical analysts seeing support at $1.0058, the 21-day moving average.

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