FOREX-Euro falls on Spanish worries, rising bond yields
* Uncertainty over Spanish bailout request unnerves market
* Spanish 10-year borrowing costs rise above 6 percent
* Bank of Spain warns of significant fall in GDP in Q3
* BOJ says ready for more monetary stimulus, yen steady
By Steven C. Johnson
NEW YORK, Sept 26 (Reuters) - The euro hit a two-week low against the dollar on Wednesday as Spain's economy weakened sharply and borrowing costs rose, increasing worries that the euro zone debt crisis is worsening.
The yen, meanwhile, held its ground against the dollar despite a Bank of Japan official warning that policymakers "won't hesitate" to launch another bout of monetary stimulus.
Traders, though, were focusing on the euro after the Bank of Spain said the economy slowed "at a significant rate" in the third quarter and protests against unpopular economic reforms in Madrid turned violent.
The news could push the government closer to requesting a bailout, something Spanish Prime Minister Mariano Rajoy told the Wall Street Journal he might do if Spain's debt financing costs stayed too high for too long.
Spain's 10-year bond yield topped 6 percent on Wednesday for the first time in a week, while the euro fell to $1.2836, a two-week low, before edging back to $1.2860, down 0.3 percent on the day.
"The more jittery the market gets about when Spain will seek aid the higher yields will go ... The key will be whether Spain asks for a bailout before their yields surge," said Paul Robson, currency analyst at RBS.
Spain's government has so far been reluctant to request aid, though doing so is a condition for the European Central Bank to help lower borrowing costs by buying Spanish debt.
Boris Schlossberg, managing director at BK Asset Management, said a Spanish bailout may not ease pressure on the euro. If Spain bows to market pressure and asks for help, he said traders may start to target Italy, which could worsen the debt crisis.
"Then you have massive risks in the euro zone," he said. The euro, which has already lost 2.5 percent since last week's four-month high around $1.3169, could fall as low as $1.25, he said. The next key level is said to be around $1.2826, the currency's 200-day moving average, traders said.
The euro also fell to a near two-week low against the yen of 99.69 yen. The risk of unrest in Greece, where the government faced its first big anti-austerity strike since taking power in June, also hurt the euro
The yen, meanwhile, held steady at 77.79 per dollar, unchanged from late Tuesday.
Warnings from Bank of Japan board member Takehiro Sato, who told Reuters policymakers were ready to expand monetary stimulus further, had little effect on the exchange rate.
Some traders said half-year book closings in Japan could pull some funds back into the country, putting mild upward pressure on the yen.
But a sustained rally was unlikely, traders said, particularly now that the Federal Reserve has committed to keeping U.S. interest rates at zero for the next three years and to pumping money into the economy until the job market improves.
Traders said they expected the yen to retest its seven-month high of 77.13 per dollar hit on Sept. 13, the day the Fed announced its aggressive easing policies.
Countering that trend, Schlossberg said, will take an equally aggressive Japanese easing campaign.
"The BoJ has been too cautious," he said. "They need a bigger, open-ended program that really lowers Japanese yields. Until then, the dollar is simply going to trade on the yield differential between Treasuries and Japanese government bonds."
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