UPDATE 2-Euro hits two-year high as banks shore up balance sheets

Fri Dec 27, 2013 8:21am EST

Related Topics

* Yen falls to fresh five-year lows vs USD & euro

* Record close on Wall Street weighs on low-yielding yen

* Sterling reaches highest versus dollar since Aug 2011

By Simon Falush

LONDON, Dec 27 (Reuters) - The euro jumped to its strongest level against the dollar in more than two years on Friday as banks adjusted positions for the year end.

The European Central Bank will take a snapshot of the capital positions of the region's banks at the end of 2013 for an asset-quality review (AQR) next year to work out which of them will need fresh funds.

This has created some demand for euros to help shore up their balance sheets, traders said.

"There's a lot of attention on the AQR, and there's some positioning ahead of the end of the calendar year," said John Hardy, FX strategist at Danske Bank in Copenhagen.

The euro gained 1.1 percent to $1.3846, and touched the day's high of $1.3894, having earlier touched its highest since October 2011.

It has risen more than 10 cents from a low hit in July below $1.28, as the euro zone economy came out of a recession triggered by its debt crisis.

Moves were exaggerated because liquidity was thin, traders said, but analysts said the euro was likely to hold its strength into 2014.

"Market price actions tend to be corrected as liquidity comes back, but I doubt that (this will happen) this time around," Hidetoshi Honda, currency strategist at Mizuho Corporate Bank said.

"Although there's no fundamental reasons to draw the euro higher, there's unlikely to be considerable retracement as liquidity comes back because the damage is already done."

Unlike the U.S. and Japanese central banks, the European Central Bank has not been expanding its balance sheet actively, giving an additional boost to the euro.

The yen touched a five-year trough against the dollar and euro, dented by a renewed appetite for risk which lifted U.S. and German equities to record highs and weighed on the low-yielding currency.

It is on course to post its ninth consecutive week of falls against the dollar, the longest such period since 1974, when the country was suffering from the aftermath of the oil crisis that started the previous year.

Many economists expect inflation in Japan to peak soon, forcing the Bank of Japan to take additional easing steps early next year to counter the impact of a sales tax hike in April.

"It looks as if there may be more ahead in terms of easing," said Geoffrey Yu, currency strategist at UBS.

The dollar rose as high as 105.05 yen before retreating to 104.92 yen, while the euro rose to 144.67 yen - highs not seen since October 2008.

The yen's decline came in thin year-end trade and was a continuation of a well-entrenched trend after Japanese authorities this year launched a shock-and-awe stimulus strategy to snap the economy out of years of deflation.

Treasury yields could rise further in 2014 if the Federal Reserve continues to scale back its bond-buying programme, having last week taken the first step towards winding down its massive stimulus plan.

The greenback also advanced against dollar-bloc commodity currencies such as the Australian dollar, but fell against sterling after strong British mortgage data reinforced expectations the Bank of England may raise interest rates sooner than previously anticipated.

Sterling reached its highest versus the dollar since August 2011, with a traders citing an option being triggered at $1.65.

It reached a peak of $1.6577 before slipping slightly to $1.6535.

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