FOREX-Euro rally loses steam as political uncertainty grows

Mon Feb 4, 2013 9:59pm EST

Related Topics

* Euro retreats from highs as traders take profit

* Corruption scandal in Spain, Italy election worries hurt euro

* Markets cautious ahead of ECB meeting Thursday

* Yen selling eases, while AUD awaits RBA rate decision

* Euro/dollar down 0.2%, dollar/yen flat

By Hideyuki Sano and Ian Chua

TOKYO/SYDNEY, Feb 5 (Reuters) - The euro was on the defensive on Tuesday as political uncertainty in Italy and Spain prompted traders to take profits on the currency's stellar gains so far this year to a 14-month high last week.

Selling pressure on the yen eased off slightly, lifting it above a 2-1/2-year low against the dollar, though traders said selling from Japanese investors curbed its gains in Asia amid entrenched expectations of more monetary easing in Japan.

The euro dipped 0.2 percent in Asia following Monday's 0.95 percent fall to trade at $1.3494, well off a 14-month high of $1.3711 set Friday.

Immediate support is seen around $1.3484, the peak for 2012, followed by $1.3255, an area that provided a floor recently.

A selloff in Italian and Spanish government bonds and stocks on Monday amid growing political uncertainty in the two countries poured cold water on optimism that Europe is slowly healing from its debt crisis.

Spanish Prime Minister Mariano Rajoy faced calls to resign over a corruption scandal, while in Italy the growing popularity of former premier Silvio Berlusconi was a worry for investors in the run-up to elections this month.

Still, not many market players think potential political upheaval could derail the euro zone's efforts to fix its debt problems.

"The euro had been buying on the thinking that the worst was over for Europe. There's a bit of adjustment yesterday after aggressive buying but I doubt people will go so far as to go short in the euro again," said a trader at a European bank.

Traders said euro bulls were already starting to turn cautious in the lead-up to Thursday's European Central Bank (ECB) policy meeting.

"The recent drawdown in the ECB's balance sheet as well as the recent rapid appreciation by the euro, has stoked not only liquidity concerns, but also concerns that euro zone exporters' competitiveness may be eroding at a very fragile time," said Christopher Vecchio, currency analyst at DailyFX.

Vecchio was referring to a recent repayment of a whopping 137 billion euros of ECB emergency loans, which slashed the amount of cash floating in the euro zone banking system.

"Accordingly, a more neutral tone is expected this week, if only to offset the prior hawkish tone set forth by the ECB at the January meeting."

Against the yen, the euro dipped below a key support at 124.62 -- the 23.6 percent retracement of its rally since late January to a 2-1/2 year high of 126.97 hit last Friday.

But euro buying from Japanese investors helped to support the euro. The euro last stood at 124.62 yen, flat from late U.S. levels.

That also helped to steady the dollar at around 92.40 yen , slightly above late U.S. levels, after its fall on Monday.

Traders suspect the yen's downtrend will remain intact with the Bank of Japan under the most pressure among major central banks to ease aggressively.

In contrast, the Reserve Bank of Australia is likely to leave its cash rate steady at 3.0 percent on Tuesday, having just cut in December. It will announce its decision at 0330 GMT.

Markets have priced in a mere 20 percent chance of a rate cut, putting the Australian dollar vulnerable to any surprise move by the central bank.

The Aussie stood at $1.0442, flat on the day holding well within its prevailing $1.0360/0480 range.

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