* Deadlock in Italian politics spurs flight-to-quality
* Cyprus crisis shatters confidence in Slovenia
* No reaction to North Korea sabre-rattling
* Yen shows limited reaction to weak Japan output data
* Focus on BOJ meeting, some see risks of disappointment
By Hideyuki Sano
TOKYO, March 29 The euro hovered near four-month lows against the dollar on Friday, beset by political deadlock in Italy and worries huge losses Cypriot depositors have been forced to stomach as part of a bailout could unnerve investors in other euro zone debt.
The market has so far shown a limited response to escalating geopolitical tension after North Korea said it had put rocket units on standby to attack U.S. military bases in South Korea and the Pacific.
The euro stood at $1.2813, little changed from late U.S. levels, though trade was thin, with many markets closed for Good Friday.
The euro was poised to end the first quarter recording a roughly 2.9 percent loss against the dollar, its first quarterly decline since the second quarter of 2012.
"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 an eight-month low on Thursday.
There is no sign of a break-through in Italian political stalemate, with centre-left leader Pier Luigi Bersani failing in his attempt to find a way out of the deadlock, prompting President Giorgio Napolitano to seek another solution.
In Cyprus, banks reopened for the first time in almost two weeks without causing a massive run on deposits, though the country conceded tight capital controls would remain in force longer than expected, likely for about a month.
The draconian rescue package for Cyprus is hurting investor confidence in Slovenia in particular.
Slovenian government bond debt yield jumped over 100 basis points on worries the central European country will need support because of its banking sector's bad loans.
"We are more likely than not to see more negative headlines from Europe. The euro will stay under pressure," said Sumitomo Mitsui's Uno.
The common currency has major support around $1.2680, a 61.8 percent retracement of its July-Feb rally, though a break there is likely to open the way for a test of last year's low near $1.20.
The euro's weakness helped the dollar stay near an eight-month high against a basket of currencies. The dollar index stood at 82.998, near Wednesday's peak of 83.302.
Against the yen, the dollar traded at 94.23 yen little changed from late U.S. levels but it looks set to mark gains for two quarters in a row, for the first time since 2009.
The U.S. currency has strong support at 93.78, the kijun line from the daily Ichimoku chart. The currency has not closed below this line since mid-November, when investors started to bet Japan would pursue aggressive monetary easing.
With so much focus on the Bank of Japan's policy meeting on April 3-4, the first one under new Governor Haruhiko Kuroda, the yen showed muted response to a barrage of Japanese data, including disappointing industrial output.
Market players expect Kuroda, seen as more dovish than former governor Masaaki Shirakawa, to scale up its bond buying and extend maturities of bonds it purchases.
But some analysts say there is 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.