FOREX-Euro rallies most in 8 mths on bond support for Italy, Spain
* ECB to be agent for rescue funds in operations-Van Rompuy
* ESM's lack of preferred credit status to Spain cheered
* Agreement upends expectations for no progress at EU summit
* China PMI on Sunday, U.S. jobs next week will be in focus
By Antoni Slodkowski
TOKYO, June 29 (Reuters) - The euro surged 1.1 percent, poised for its biggest daily jump in eight months, after European leaders agreed on Friday to emergency action to lower borrowing costs of Italy and Spain and to create a single supervisory body for euro area banks.
A summit of the 17-nation currency zone agreed that its rescue funds could be used to stabilise bond markets without forcing countries that comply with EU budget rules to adopt extra austerity measures or economic reforms.
"If what he (European Council chairman Herman Van Rompuy) said was indeed agreed by EU leaders, that would clearly go beyond market expectations and should be enough to stop risk aversion in financial markets," said Hiroki Shimazu, senior market economist at SMBC Nikko Securities.
The common currency soared more than 1.2 percent on a flurry of stop-loss buying to as high as $1.2628, pulling away from a low of 1.2407 marked on Thursday. It later settled around 1.2573.
The leaders also agreed that the bloc's future permanent bailout fund, the European Stability Mechanism (ESM), would be able to lend directly to recapitalise banks without increasing a country's budget deficit, and without preferential seniority status.
The preferred creditor status of the ESM worried markets, piling pressure on Spanish bonds, because investors were concerned that if Spain were to default, the ESM would get paid back first and there would not be enough money left to repay private bondholders.
"Because market expectations on the summit were so depressed, it was a bit like there was a drop of rain in the desert," Ayako Sera, senior market economist at Sumitomo Mitsui Trust Bank.
"Van Rompuy suggested that the EU is considering direct bank recapitalisation of banks through the ESM. It seems like the summit is moving in a favourable direction for markets," Sera said.
Chartists pointed out, however, that the euro failed to decisively move above the immediate resistance at 1.2617 - the 61.8 percent retracement of its slump over the past two weeks. A clear break above the resistance and then 1.2630 would pave the way for a return to last week's high at 1.2748.
Countries that request bond support from the rescue fund would have to sign a memorandum of understanding setting out their existing policy commitments and agreeing on a timetable. But they would not face the intrusive oversight of a "troika" of international lenders to which Greece, Ireland and Portugal have been subjected, Italian Prime Minister Mario Monti said.
Spain and Italy had earlier withheld their agreement to a growth package at a European Union summit to demand emergency steps to bring down their spiralling borrowing costs, which threaten to force the third and fourth largest economies in the euro zone out of the capital markets.
Against the yen, the euro jumped 1.1 percent to 99.86 yen, pulling away from a low of 98.37 plumbed on Thursday.
But the Japanese unit held its ground against the dollar as Japanese exporters offloaded the U.S. currency in vast quantities in end-of-quarter transactions, traders said.
As a result, the dollar dropped to a 1-1/2 week low against the yen of 79.31.
High-beta Australian dollar hit a one-week high on the euro zone news. The Aussie jumped 1.1 percent to $1.0152.
It has broken above solid resistance at $1.0128 - the 61.8 pct retracement of its June 20-25 fall - opening the door for a return to last week's high of $1.0225.
With risk currencies and the yen on the offensive, the dollar index - the gauge of the greenback's performance against a basket of major currencies - dropped 1 percent to a one-week low of 81.82, before steadying at 82.00.
WAITING FOR CHINA
After the summit euphoria drops off, markets will have to contend with the latest reading on China's manufacturing sector. Due on Sunday, the official survey of China's factories is likely to show activity fell to seven-month lows in June.
Such an outcome would compound market concern that the world's second-largest economy is stuck in a deeper and longer downturn than previously expected, a negative for risk sentiment.
Markets will also be bracing for a slew of U.S. data in a holiday-shortened week ahead, culminating in the closely watched non-farm payrolls data on Friday, July 6.
The latest jobless benefits claims report indicated the U.S. job market was still struggling to gain traction. It came as government data confirmed the U.S. economy grew only modestly in the first quarter.
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