FOREX-Euro hits six-week trough on lower ECB loan pay-back
* Euro hurt by smaller-than-forecast crisis loan repayment
* EU Commission forecasts euro zone economy to shrink
* Markets wary ahead of Italian election
By Nia Williams
LONDON, Feb 22 (Reuters) - The euro hit a six-week low versus the dollar on Friday after the European Central Bank said banks would pay back 61.1 billion euros of the second of two crisis loans, less than half the amount expected by the market.
The smaller-than-expected repayment signalled some banks still felt the need to keep hold of the ultra-cheap emergency loans, and means the ECB's balance sheet will shrink at a slower pace.
A report from the European Commission that forecast the euro zone economy will contract again in 2013 and caution ahead of an Italian election this weekend also weighed on the euro.
The euro fell as low as $1.3157, its lowest since Jan. 10, retreating from a session high of $1.3246 touched after a better-than-forecast German Ifo survey suggested a brighter outlook for the euro zone's largest economy.
It was last down 0.1 percent on the day at $1.3170, with market players reporting supporting bids around $1.3150-60.
"The market was expecting a much bigger drain of liquidity from the system than was shown, which means people perceive ECB policy will take much longer than expected to normalise," said Adam Myers, senior FX strategist at Credit Agricole.
"That undermines the euro, especially given we had a much more hawkish than expected Federal Reserve minutes."
The euro has come under heavy pressure against the dollar since minutes on Wednesday fuelled speculation U.S. policymakers may start to tighten monetary policy earlier than thought.
Some strategists said they expected the euro to grind lower ahead of the Italian elections, although it should find support around $1.3040, near the Jan. 10.
Investors were wary about the risk of a fragmented Italian parliament or resurgence from former prime minister Silvio Berlusconi, which could hinder the euro zone's third-biggest economy from fighting its longest recession in 20 years.
"The Italian elections are more difficult to predict, if Berlusconi and his parties occupy prominent positions then they really could be a thorn blocking legislation and that is a big uncertainty and the markets doesn't know how to play that," said Neil Mellor, currency strategist at Bank of New York Mellon.
The result of the Italian vote is not expected until next week.
The euro and the dollar rose against the yen, although strategists said the Japanese currency's three-month decline was showing signs of losing momentum.
Expectations the new Japanese government will take aggressive easing steps in an attempt to revive the economy have helped the yen fall steeply across the board since November.
The dollar rose 0.15 percent on the day to 93.24 yen, keeping some distance from a 33-month high of 94.47 hit last week. The euro edged up 0.1 percent to 122.93 yen.
Some market players said the fact U.S. policymakers had not particularly objected to yen weakness, which makes Japan's exports more competitive relative to those of other countries, meant the downtrend could continue.
"We didn't really realise how aggressive the Japanese officials would get and we also didn't really sense the U.S. condoning it as much as they did," said John Vail, chief global strategist at Nikko Asset Management.
"It could be that they (the U.S.) are quite willing to let the yen get to this level. My sense is that the 95-105 yen level is the intended range."
Meanwhile, the Australian dollar regained ground after falling to a four-month low of US$1.0221 against a broadly stronger U.S. currency on Thursday. The Aussie rose 0.9 percent to US$1.0334.
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