Euro knocked by sovereign debt fears, yen shines

SYDNEY (Reuters) - The euro nursed heavy losses early in Asia on Tuesday while the yen gained across the board as worries about sovereign debt problems in Europe and the United States prompted investors to unwind carry trades.

Already hit by fears that Greece will have to restructure its mountain of debt, possibly as early as this summer, market sentiment took a further dive after Standard & Poor's threaten to downgrade the United States' prized AAA credit rating.

"Discussions on the U.S. losing its AAA-status have been active for two years, if not longer. S&P's move might have been a jolt, but should not really be a true surprise," said David Watt, senior currency strategist at RBC Dominion Securities.

S&P slapped a negative outlook on the U.S. top-notch rating and said there was at least a one-in-three chance that it could be eventually cut, unless the Obama administration and Congress find a way to slash the yawning federal budget deficit within two years.

The twin drivers saw Wall Street post its biggest fall in a month, and provided investors a timely excuse to take profits on long positions in currencies like the Aussie dollar ahead of the Easter holidays. This helped the yen, which had recently been dumped, rise broadly.

The euro fell to as low as 116.41 yen -- the lowest since March 30. It was currently flirting with 117.28, a level representing the 38.2 percent retracement of its March to April rally.

The dollar also underperformed the yen, falling to a near three-week low around 82.16, before recovering slightly to last stand at 82.40.

Against the dollar, the euro slid to a two-week low around $1.4155. It last traded at $1.4227.

This helped the dollar index .DXY, which tracks its performance against a basket of major currencies, rise to two-week highs of 75.810, well off a 16-month low of 74.716 set last week.

Still, analysts said the longer-term bearish views on the U.S. dollar and yen remained intact with both the Federal Reserve and Bank of Japan set to keep monetary policy ultra-loose, maintaining their funding-currency status.

In fact, the early threat of a downgrade may help U.S. policy leaders to make progress on agreeing to substantial budget cuts, said Michael Sneyd, analyst at Societe Generale.

"All-in-all, we expect a rebound in risk once the heavy de-leveraging has run its course, but this may take until after the Easter break and EURJPY should then be the best performer."

The Aussie dollar shed about a cent to a low of $1.0454, before edging back up toward $1.05. It remained not far off a 29-year high of $1.0585 set on April 8. But it jumped on the euro, which skidded to a seven-week low of A$1.3520.

(Editing by Wayne Cole)