FOREX-Cyprus and Italian problems keep euro near recent lows
* Euro wallows near four-month lows vs USD
* Italy's funding costs rise, Cyprus banks set to reopen
* Yen slide loses downward momentum as BOJ meeting awaited
By Anirban Nag
LONDON, March 28 (Reuters) - The euro struggled near four-month lows against the dollar on Thursday and could ease more, hurt by the risk of capital outflows due to the fallout from a rescue deal for Cyprus and ongoing political problems in Italy.
Cyprus opens its banks on Thursday with tight controls in place to prevent a bank run. While that should slow the pace of deposit withdrawals, the euro was vulnerable given concerns the Cyprus deal, where depositors and private bondholders are left with huge losses, instead of taxpayers, could become a template for future bank bailouts for struggling euro zone countries.
That could encourage jittery investors to sell euro zone assets and prefer the safety of the dollar, the yen, the Swiss franc or even the British pound. These concerns along with ongoing political uncertainty in Italy, and a weak economic outlook across the euro zone would keep the euro pinned down, analysts said.
The euro was down 0.1 percent on the day at $1.2770, not far from a four-month low of $1.2750 hit on Wednesday. Traders said month-end demand from investors rebalancing their bonds and stocks portfolio would offer it some support, but any bounce towards Wednesday's high of $1.2867 would see fresh selling.
"It is the worry about the broader euro zone banking system and the slow contagion that we could see from the Cyprus bailout deal along with the political uncertainty in Italy that will see downward pressure on the euro," said Simon Derrick, head of currency strategy at Bank of New York Mellon.
"We could see the euro towards the low $1.20s by year-end."
Italy's borrowing costs rose on Wednesday with Italian centre-left leader Pier Luigi Bersani left with only slim hope of forming a government after talks with rival party leaders ended with rejection from Beppe Grillo's 5-Star Movement.
"If Italy has to hold a re-election, that will surely remind the market of a fall in the euro after Greece was forced to hold a re-election last year," said Ayako Sera, market economist at Sumitomo Mitsui Trust bank.
Given the ongoing problems in the euro zone, investors chose the safety of the more liquid yen. The euro was down 0.2 percent against the yen at 120.40 yen, not far from a one-month low of 119.945 struck on Wednesday.
The yen also gained on talk of repatriation flows by Japanese investors before the end of the financial year on March 31. That gave the currency a reprieve after it saw a period of sustained weakening due to expectations - now heavily priced in - of aggressive monetary easing by the Bank of Japan at new governor Haruhiko Kuroda's first policy review on April 3-4.
Some analysts say given high expectations of aggressive easing from the Bank of Japan, there is a risk of disappointment. That could give the yen a boost after the BOJ policy meet.
The dollar was down 0.3 percent at 94.15 yen with bids to buy the U.S. currency cited at 94 yen.
"The market was pricing in 'surprise' easing but there's no surprise anymore, nothing new in Kuroda's statements, so people are inevitably covering their yen shorts," said Masashi Murata, senior currency strategist at Brown Brothers Harriman in Tokyo.
U.S. data like jobless claims, the final reading of fourth-quarter gross domestic product and the Chicago PMI are all due on Thursday and better-than-expected numbers could give the dollar a boost.
(Editing by Chris Pizzey, London MPG Desk, +44 (0)207 542-4441)
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