FOREX-Euro drops as Italian vote spurs fears about its economy
* Yen falls on talk of new dovish BoJ chief
* UK rating downgrade pushes sterling to multi-month lows
* Focus on U.S. spending cut negotiations
By Julie Haviv
NEW YORK, Feb 25 (Reuters) - The euro slumped against the dollar and Japanese yen on Monday after exit polls from an election in Italy ignited fears about government instability and concerns about the country's economic trajectory.
Projections from an early vote count showed former premier Silvio Berlusconi's centre right slightly ahead in the Senate, the reverse of earlier predictions from telephone polls of the centre left taking a strong lead in both houses of parliament.
A centre left government, probably backed by outgoing technocrat premier Mario Monti, was seen as the best guarantee of measures to combat a deep recession and stagnant growth in the euro zone's third largest economy, which is pivotal to stability in the currency union.
The euro had earlier been trading sharply higher as a successful Italian bond sale and hopes of a centre left government buoyed the currency, but that dissipated when the exit polls emerged.
"A centre right victory or a hung parliament threatens the continuity of Monti's painful, but necessary fiscal reforms that have been in place," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington D.C.
He said the inconclusive results so far are weighing on Italian bond yields, which in turn is also hurting the euro.
Against the dollar, the euro last traded at $1.3174, down 0.1 percent on the day. It earlier hit a session low of $1.3158, not far from a six-week low of $1.3144 hit on Friday.
The euro last traded flat at 123.18 yen, sharply below a high of 125.25 hit earlier in the session. It also held below the 34-month peak of 127.71 set earlier this month.
The euro could continue to lose ground should risk appetite abate. If Washington D.C. politicians do not reach an agreement on a deficit reduction deal this week, $85 billion in spending cuts will automatically kick in on March 1.
Concerns about global economic growth could also weigh on risk sentiment.
Growth in China's giant manufacturing sector in February pulled back from two-year highs despite a fourth consecutive month of expansion, a private survey showed on Monday, as foreign demand remained unsteady.
YEN REBOUNDS FROM 33-MONTH LOW VERSUS DOLLAR
The yen earlier hit a 33-month low against the dollar on bets the Japanese government will tap strong proponents of aggressive monetary easing for top Central Bank positions.
The yen fell for a second straight session against the dollar on news that Japan's prime minister is likely to nominate Asian Development Bank President Haruhiko Kuroda as the next central bank governor to step up his fight to finally rid the country of deflation.
Prime Minister Shinzo Abe won a big election victory in December promising to revive the fortunes of an economy stuck in the doldrums for most of the past two decades.
Abe's repeated calls for more forceful central bank action are largely behind the currency's nearly 20 percent loss in value against the dollar since November.
"The news all but ensures that the BoJ will continue on an expansionary path of monetary easing to help kick start the world's number three economy," Commonwealth's Esiner said.
"Consequently, the yen remains vulnerable to continued losses across the board," he said.
Like the U.S. Federal Reserve, the Bank of Japan has cut interest rates close to zero. Since then it has adopted unorthodox measures to inject cash into the economy, currently in its fourth recession since 2000, to try to stimulate growth.
The dollar shot up to 94.76 yen earlier on Monday, a high not seen since May 2010. The U.S. currency last traded at 93.48 yen, up 0.1 percent on the day, according to Reuters data.
Some analysts said the yen would remain on a weakening trend, although the dollar would face resistance at the psychologically important level of 95 yen.
"Dollar/yen has moved on the back of talk that Kuroda is going to head up the BOJ and he is going to be inclined to crank up the printing presses," said Neil Mellor, currency strategist at Bank of New York Mellon.
Sterling, meanwhile, slumped to multi-month lows against the dollar and the euro after the UK lost its prized triple-A credit rating on Friday.
Moody's cut Britain's rating by one notch to Aa1 from Aaa, citing weak prospects for economic growth.
Sterling fell to a 16-month low versus the euro of 87.75 pence per euro and 31-month low against the dollar of $1.5073.
It looked likely to remain vulnerable on expectations the Bank of England could expand its quantitative easing further to bolster the fragile UK economy.
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