FOREX-Euro weakens vs dollar, vulnerable to developments in Cyprus
* Euro weak near 3-month low vs dollar on Cyprus problems
* Investors await vote on Cyprus bailout deal
* Little impact from better-than-expected German ZEW
By Anirban Nag
LONDON, March 19 (Reuters) - The euro fell on Tuesday, with investors nervous ahead of a vote in Cyprus on a controversial bank deposit levy that has fuelled concerns of fresh euro zone instability.
A Cyprus government spokesman said a plan to levy taxes on bank deposits, crucial for the country to secure financial aid, was unlikely to be approved by parliament on Tuesday. That would push the island closer to a default and a banking collapse that could have repercussions across the euro zone.
It could also inject fresh volatility into financial markets and weigh on the euro. Safe-haven German bund futures were higher On Tuesday while European stocks fell.
The single currency fell 0.1 percent against the dollar to $1.2946, holding within sight of Monday's three-month low of $1.2882. Below that, support was expected around the 200-day moving average at $1.2874.
"If the vote doesn't go through, it would lead to another precipitous fall in the euro as worries about a banking crisis will escalate," said Adam Myers, European head of FX strategy at Credit Agricole. He expects the euro to drop to $1.27 in coming months.
The euro gained a short-lived boost from a slightly better-than-expected German ZEW economic sentiment survey, but demand was hampered by worries about Cyprus.
Tohru Sasaki, head of Japan rates and FX research at JPMorgan Chase Bank, said the euro looked vulnerable. Its rebound from Monday's three-month low was much smaller than its bounce after the fall triggered by a Greek election last May, when investors were unnerved by the ruling coalition's failure to win a majority.
Against sterling, which is often bought as a shelter in times of heightened uncertainty in the euro zone, the euro hovered near a five-week low of 85.32 pence hit on Monday to change hands at 85.55 on Tuesday.
The euro also retreated against the Swiss franc, dropping 0.2 percent on the day to 1.2227 francs.
Analysts said the unprecedented plan to impose taxes on citizens' savings in Cyprus, announced over the weekend, had rattled savers in larger European countries also burdened by heavy debts, like Spain and Italy.
As a result, the more liquid dollar and the Japanese yen, often sought during times of financial instability and economic stress, should remain supported.
UBS strategist Geoffrey Yu, however, said the euro looked vulnerable but losses should be capped as long as investors did not start withdrawing funds from other euro zone countries, or rush to empty cash machines as they have done in Cyprus.
"We are not seeing huge queues at ATMs (cash machines) in Italy and Spain ... that contagion is contained. We have revised our one-month forecast in euro/dollar to $1.30," he said.
The dollar index, which measures the greenback against a basket of currencies, was close to flat on the day at 82.680.
The dollar was up 0.1 percent on the day at 95.27 yen with the Japanese currency likely to be driven by any comments from incoming governor of the Bank of Japan Haruhiko Kuroda, who assumes the post on Wednesday.
Expectations are huge for Kuroda to put in place an aggressive monetary policy to try and lift Japan out of deflation and which is likely to weaken the yen.
Market players said if the situation deteriorates in Cyprus the safe-haven yen could regain ground, pushing the dollar further away from last week's 3-1/2 year high of 96.71 yen.