FOREX-Euro drops on Italian gridlock; Bernanke defends bond buying
* Euro steady after hitting a 7-week low
* Italy political gridlock sends borrowing costs higher
* Fed's Bernanke strongly defends bond buying program
* U.S. housing and confidence data reflect strength
By Julie Haviv
NEW YORK, Feb 26 (Reuters) - The euro dropped against the dollar on Tuesday and was seen susceptible to further selling as political gridlock in Italy caused the government's borrowing costs to jump, reigniting fears about the euro zone's debt crisis.
The dollar, meanwhile, slumped for a second straight day against the yen after Federal Reserve Chairman Ben Bernanke adamantly defended the benefits of the U.S. central bank's bond-buying program in testimony before Congress.
The euro rebounded from a seven-week low as investors sought to buy at cheaper levels brought on by the electoral stalemate in Italy, the euro zone's third-largest economy, which could leave its economic reform efforts in tatters.
The Italian stock market plunged while state borrowing costs rose after a stunning election that saw a comedian's protest party lead the poll and no group secure a clear majority in parliament. Euro zone shares sank to three-month lows.
Any coalition administration that may be formed must have a working majority in both houses in order to pass legislation.
"The bad part of the results is that there is now a 'hung parliament,' or divided government," said Christopher Vecchio, currency analyst at DailyFX, in New York. "The lower and upper houses of parliament share power; thus, when each branch breaks into different ideological directions, the country is essentially at an ungovernable impasse."
The euro last traded at $1.3048, down 0.1 percent on the day, but above a low of $1.3017 hit during early London hours, which was the lowest level since Jan. 7.
Although the euro is near oversold conditions, momentum amid political distress tends to supersede stretched technical indicators, according to Vecchio.
Against the yen, the euro last traded down 0.6 percent at 119.24 yen, not far from a one-month low of 118.74 yen struck on Monday when it posted its single biggest percentage loss since early May 2011.
The euro has steadily lost ground this month, retreating from a 15-month high against the dollar and a near three-year high against the yen. That is a swift turnaround from the start of 2013 when the euro rallied on hopes the worst of the euro zone debt crisis was over.
Recent data has reminded investors that the region is still grappling with a recession as southern European countries struggle to bring down high debt levels by imposing painful austerity.
"For the euro, the focus is on the 2013 lows below $1.30, and events in Italy show that politicians are pushing back at fiscal austerity measures," said Paul Robson, currency strategist at RBS. "It is negative for the euro, and until it remains below $1.3170, it will remain a sell on rallies."
Strategists said Italy faces a larger hurdle on Wednesday when it offers the market up to 6.5 billion euros of 5- and 10-year bonds, which would test foreign investors' appetite for Italian assets.
Federal Reserve Chairman Ben Bernanke strongly defended the U.S. central bank's bond-buying stimulus before Congress on Tuesday, saying its benefits clearly exceed possible costs.
Bernanke also urged lawmakers to avoid the sharp spending cuts set to go into effect on Friday, which he warned could combine with earlier tax increases to create a "significant headwind" for the economic recovery.
The Fed is currently buying $85 billion in bonds each month and has said it plans to keep purchasing assets until it sees a substantial improvement in the outlook for the labor market.
The Fed's bond buying is seen as negative for the dollar as it is tantamount to printing money and dilutes its value.
The dollar last traded at 91.34 yen, down 0.5 percent on the day and not far from a low of 90.92 yen on Monday, its lowest in nearly a month.
While expectations of more monetary easing by the Bank of Japan could pressure the yen, the Japanese currency could remain supported at the expense of growth-linked currencies if risk appetite abates.
Also on Tuesday, the focus on Italy temporarily took a backseat to U.S. economic data.
U.S. home prices closed out 2012 with the biggest annual gain in more than six years, according to the S&P/Case Shiller index, while government data showed that sales of new homes spiked in January, the latest sign that the long-suffering housing market was on the mend.
Consumer confidence rose more than expected this month as Americans shrugged off worries about fiscal policy.
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