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Thu 17 Nov 2011 08:49 AM

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Euro hits 5-week low as contagion fears intensify

Bond market turmoil spreads across Europe, sparking calls for ECB to intervene forcefully

Euro hits 5-week low as contagion fears intensify
Against the yen, the eurozone single currency eased 0.1% to 103.62 yen

The euro hit five-week lows versus both the dollar and the yen on Thursday as bond market turmoil spread across Europe, sparking calls for the European Central Bank to intervene more forcefully in markets.

Investors were also nervously watching to see how German financial markets will react after rating agency Moody's Investor Service cut ratings of 12 German public-sector banks, believing they are likely to receive less federal government support if needed.

The euro eased 0.1 percent to $1.3452, having dipped to as low as $1.3421 on trading platform EBS earlier, its lowest level since Oct. 10.

Support lies at around $1.3405, the 76.4 percent retracement of the October rally. The bottom of the weekly Ichimoku cloud also offers support near that level, coming in at $1.3408.

"There are signs of more widespread contagion in the eurozone outside of Italy and Spain with spreads widening this week in Austria, France and Belgium," said Chris Gothard, head of FX for Brown Brothers Harriman in Hong Kong, referring to yield spreads against German bonds.

While the euro will remain sensitive to headlines and could see some short-covering rallies, it will probably decline further in coming weeks and months, Gothard said.

"We think there are further downside risks from here with a convincing downside break of $1.3400 opening up the door to test the recent lows near $1.3150," he said, adding that his bank's forecast is for the euro to drop to $1.29 by year-end.

Against the yen, the single currency eased 0.1 percent to 103.62 yen, having hit a five-week low of 103.40 yen earlier on Thursday.

There was talk of some stop-loss offers around that level, while support comes in near 103.32 yen, the 76.4 percent retracement of the euro's rally in October.

Yunosuke Ikeda, senior currency analyst at Nomura in Tokyo, said the euro could take a hit if there is a margin hike on Spanish bonds, which could take place soon after bond clearing house LCH. Clearnet raised margin requirements on Italian debt last week, a move that sparked a selloff in Italian debt.

Later on Thursday, the euro is likely to take its cues from auctions of up to €11bn of Spanish and French bonds.

Spain's sale of new 10-year debt comes as the country's finances are under renewed scrutiny just days before a general election and Madrid is expected to face its highest borrowing cost since the euro's inception in 1999.

In a further blow to risk appetite, Fitch warned it may downgrade its "stable" outlook for US banks, because of contagion from problems in troubled European markets.

"While US banks have been under scrutiny for some time over their exposure to Europe, an explicit warning from the ratings agency amplified market concerns over the extent and impact of contagion," said analysts at BNP Paribas.

French borrowing costs continued to rise on Wednesday and ECB buying of Italian and Spanish debt failed to reassure markets. There were also growing signs of strain in money markets, with euro zone banks finding it harder to obtain dollar funding.

However, Germany remained resolutely opposed to letting the central bank take a bigger role in resolving the debt crisis, even though many analysts believe the only way to stem the contagion is for the ECB to carry out the sort of quantitative easing undertaken by the US and British central banks.

All these factors helped drive the dollar index to a five-week high of 78.467. It last stood at 78.339.

Commodity currencies bore the brunt of the dip in risk appetite with the Australian dollar hitting a five-week low of $1.0021. The Australian dollar was changing hands at $1.0052, down 0.3 percent from late US trade on Wednesday.

"The AUD/USD remains under downward pressure and could try to push under parity to a support pivot point of $0.9986 in the near term," said Besa Deda, chief economist at St. George Bank.

Among the G3 currencies, dollar/yen remained a sea of calm as the danger of more intervention by Japan kept markets wary. Dollar held steady at 77.04 yen, having settled into a range roughly between 76.80 yen to 77.50 yen this week.

Japan conducted massive yen-selling intervention on Oct. 31 in a bid to curb the yen's strength, after the dollar fell to a post-World War Two record low near 75.31 yen.

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