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Tue 19 Jul 2011 10:27 AM

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Euro steady but Europe's debt woes cast pall

Single currency outlook clouded by concerns that debt crisis may drag in Italy, Spain

Euro steady but Europe's debt woes cast pall
MONEY MATTERS The euro stabilised versus the dollar after having bounced off chart support near $1.4007 the previous day (Bloomberg Images)

The euro held steady on Tuesday, taking a breather after its slide to a record low versus the Swiss franc the previous day, but is still vulnerable to fears that Europe's debt crisis could worsen.

The single currency stabilised versus the dollar after having bounced off chart support near $1.4007 the previous day, and could extend that rebound given market talk of stop-loss bids near $1.4140.

But its outlook was clouded by heightened concerns that the debt crisis engulfing Greece may ensnare Italy and Spain as well.

Highlighting such worries, yields on both Italian and Spanish 10-year government bonds climbed above 6 percent on Monday, taking them closer to the 7 percent level, beyond which funding costs are perceived to be unsustainable.

"Italian and Spanish government bond yields have risen pretty sharply. If that continues, a risk-off trend on the back of concerns about Europe could continue and spur buying of both the yen and the dollar against the euro," said Junya Tanase, chief FX strategist for JPMorgan Chase Bank in Tokyo.

The 7 percent level is seen as a threshold level for gauging whether Italy and Spain can keep raising funds from the market, Tanase said, adding that both Ireland and Portugal had requested international aid shortly after their 10-year government bond yields rose above 7 percent.

The euro edged up 0.1 percent versus the Swiss franc at 1.1543, having bounced up from a record low of 1.1365 hit on Monday on trading platform EBS. Against the dollar, the euro held steady at $1.4109.

The single currency's drop the previous day, on the back of concerns that recent stress tests of European banks were not stringent enough, had stalled near support at $1.4007, a 61.8 percent retracement of the euro's rise last week to $1.4282 from a four-month low near $1.3838.

There was talk of good demand for euros near $1.4050, and traders cited stop-loss euro bids around $1.4140.

Euro-zone leaders will meet on Thursday to try to finalise a second round of aid for Greece worth EUR110bn ($154bn).

But it remained unclear how a consensus could be reached for private owners of Greek government bonds - banks, insurers and other investors - to contribute by taking cuts in the face value of their holdings.

Since the focus is on a new rescue package for Greece, the euro zone leaders' meeting is unlikely to produce specific steps to address the rise in Italian and Spanish bond yields, said JP Morgan's Tanase.

To be sure, worries about government debt were also hanging over the dollar, with investors fretting a stalemate in Washington over raising the US government's $14.3 trillion borrowing limit.

Most market players, however, are betting that a deal will be reached in time and that the United States will avoid defaulting on its debt.

Given this backdrop, the risks for the euro against the dollar seem to be tilted toward the downside, said Koji Fukaya, director of global foreign exchange research at Credit Suisse Securities in Tokyo.

"I think there is a fundamental difference in meaning between the truly serious debt problems in the Europe on the one hand, and the fact that there is some contentious debate (in the US) on the other," Fukaya said.

The dollar edged up 0.1 percent against the yen to 79.08 yen, staying above a four-month low of 78.45 yen hit last week on EBS.

Although that drop in dollar/yen last week sparked some jitters about the potential for yen-selling intervention, market players say Japanese authorities seem unlikely to intervene unless moves in dollar/yen turn more volatile.

The Australian dollar rose 0.2 percent to $1.0631. The Aussie took only a brief knock after the Reserve Bank of Australia moved away from an explicit warning of higher interest rates.

"The minutes struck a slightly cautious tone about future tightening and weighed on the currency a bit, but there were no surprises to push the currency much lower," said Shuichi Kanehira, head of FX spot trading at Mizuho Corporate Bank in Tokyo.

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