FOREX-Euro tumbles on soft euro zone data, ahead of Italy vote
* Euro drops after euro zone PMI surveys
* Prospect of hung Italian parliament weighs on euro
* Dollar index hit 5-month high
By Gertrude Chavez-Dreyfuss
NEW YORK, Feb 21 (Reuters) - The euro dropped to a six-week low against the dollar and a three-week trough against the yen on Thursday in the wake of data showing a struggling euro zone economy and amid uncertainty ahead of Italy's election at the weekend.
Expectations that the U.S. Federal Reserve may start reducing monetary stimulus earlier than thought also helped the dollar gain broadly.
The euro zone purchasing managers' data for February pointed to continued weakness in the region, keeping alive chances of an interest rate cut by the European Central Bank in coming months.
"The PMI news is not good and shows the euro zone is under economic duress and you add to the current uncertainty ahead of the Italian elections and we have a euro that is struggling to get ahead," said Matthew Lifson, senior trader and analyst at Cambridge Mercantile Group in Princeton, New Jersey.
Prospects of a fragmented parliament after Italy's national election could trigger a sell-off in the peripheral bond market and weigh on the euro.
The euro dropped to $1.3166, its lowest since Jan. 10, and well below a 15-month peak of $1.3711 reached on Feb. 1. The euro last traded at $1.3209, down 0.5 percent.
It has now broken below support at $1.3310, the 38.2 percent retracement of its November-February rally, and its 55-day moving average at $1.3285. The losses leave it open for a test of the Jan. 10 low of around $1.3040.
Against the yen, the euro fell to 122.23 yen, its weakest level since late January. It was last at 122.91, down 1.1 percent.
David Mackie, European economist at JP Morgan in London, said although the euro zone is making progress, the past month has seen a broad-based disappointment on the macroeconomic front.
"An exit from recession is still likely, but the journey looks to be slower and bumpier than we were expecting and the improvement in economic activity looks to be disproportionately skewed towards Germany," Mackie said.
He added that the recent round of weak data would be enough reason for the ECB to cut rates.
The single currency was already under pressure against the dollar after minutes from the Federal Reserve's January policy-setting meeting released Wednesday showed "a number of participants" had expressed concern over the risks of continued asset purchases.
"Those Fed minutes really hit long euro positions in most crosses," Cambridge's Lifson said.
Despite the euro's broad weakness, BNP Paribas said the reaction to the Fed minutes was overdone and recommended buying the single currency against the dollar, with a target of $1.38.
DOLLAR INDEX GAINS
The Fed minutes fueled speculation among market players that the Fed is moving closer to tightening policy, helping push the dollar index to a five-month high of 81.508.
The index had posted its biggest one-day gain in seven months on Wednesday and last quoted at 81.354, up 0.4 percent.
Broad demand for the dollar helped push the U.S. currency to a one-month high against the Swiss franc of 0.9330 franc, and a four-month peak against the Australian dollar at US$1.0265.
As the Fed considers the eventual end of its asset buying, the dollar stands to gain against currencies like the yen and the British pound. Both the Bank of Japan and Bank of England are considering printing more money and expanding their balance sheets, driving down the value of their currencies.
The dollar has gained more than 7 percent against the yen while sterling has lost 6 percent so far this year.
The yen has been the worst performing major currency so far in 2013 as investors bet on more aggressive policies from the Bank of Japan to reflate the world's third-biggest economy.
On Thursday, the dollar took a breather from its recent rally and was trading down 0.4 percent at 93.22 yen.
U.S. data showing initial jobless claims rose more than expected in the latest week added to the dollar's losses against the Japanese currency, as did an unexpectedly weak survey of business activity in the U.S. mid-Atlantic region.
Morgan Stanley strategists said the dollar's decline was likely to be limited around the 92.90 yen area, the low struck on Feb. 12, and the greenback would eventually rise to test its recent near three-year highs of around 94.50 yen.
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