FOREX-Euro bounces slightly, but Italy deadlock weighs

Thu Mar 28, 2013 11:57pm EDT

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* Fears over Italian politics spur flight-to-quality

* Cyprus crisis sends jitters through Slovenian debt market

* No reaction to North Korea sabre-rattling

* Yen shows limited reaction to weak Japan output data

* Focus on BOJ meeting, some see risk of disappointment

By Sophie Knight and Hideyuki Sano

TOKYO, March 29 (Reuters) - The euro edged up on Friday but stayed near four-month lows against the dollar, beset by political deadlock in Italy and worries the huge losses suffered by Cypriot depositors as part of a bailout could unnerve investors in other euro zone debt.

But trade was subdued with many markets closed for Easter holidays, and there was limited reaction to North Korea putting its missile units on standby to attack U.S. military bases in South Korea and the Pacific.

The common currency stood at $1.2830, up 0.1 percent from late U.S. trade. It was set to end the quarter down roughly 2.7 percent against the dollar, its first quarterly decline since the April to June period in 2012.

The common currency has major support around $1.2680, a 61.8 percent retracement of its July-February rally, though a break there is likely to open the way for a test of last year's low near $1.20. There were also signs that dip-buying could prevent any sharp falls for now.

"Some U.S. hedge funds are trying to take long positions on the euro on the dip," said a trader at a domestic bank who declined to be named.

However, the common currency still faces vigorous headwinds.

There is no hint of a breakthrough in Italy's political stalemate, with centre-left leader Pier Luigi Bersani's failure to find a way out of the deadlock prompting President Giorgio Napolitano to go in search of another solution.

In Cyprus, banks reopened for the first time in almost two weeks without causing a feared run on deposits, though the country conceded tight capital controls would remain in force longer than expected, likely for about a month.

"The euro appears to be stabilising just for now, but European bond markets are clearly showing a rather different picture," said Daisuke Uno, chief strategist at Sumitomo Mitsui Bank.

In a sign nervous investors are shifting funds back to safe-haven German bonds, the 10-year German Bund yield fell to its lowest since July last year, when borrowing costs for Spain and Italy rocketed to levels seen as unsustainable.

The draconian bailout conditions for Cyprus have soured investor sentiment particularly in Slovenia, which is seen as one of the next potential candidates for a future euro zone bailout due to the bad loans hampering its banking sector.

Slovenian government bond debt yields have jumped over 100 basis points in the last week or so.

The small bounce for the euro helped pull the dollar further from Wednesday's eight-month high of 83.302 against a basket of currencies. The dollar index lost 0.4 percent to 82.906 on Friday.

FEELING GUTSY?

The greenback also slipped 0.1 percent against the yen to 94.07 as the last of Japanese exporters' repatriation flows trickled through on the last trading day of the financial year.

Expectations of gutsy easing from the Bank of Japan at its monetary policy review next week have left the yen poised to record an 8.4 percent quarterly loss against the greenback, which would mark a slide for two quarters in a row for the first time since 2009.

With so much focus on the BOJ's policy meeting on April 3-4, the first one under new Governor Haruhiko Kuroda, the yen showed a muted response to a barrage of Japanese data, including disappointing industrial output.

Market players expect Kuroda to scale up BOJ bond buying and extend maturities of bonds it purchases.

But some analysts say there is a risk of disappointment.

"I expect the yen to gain after the BOJ meeting next week. So much has been said about aggressive easing already and I can't expect anything new," said Sumitomo Bank's Uno.

The U.S. currency has strong support at 93.78, the kijun line from its daily Ichimoku chart. It has not closed below this line since mid-November, when investors started to bet Japan would pursue aggressive monetary easing.

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