November 3, 2011 / 11:46 AM / 6 years ago

FOREX-Euro rebounds as Greek chaos raises referendum doubts

* Euro rebounds as Greek chaos threatens bailout referendum

* Volatile crisis still warrants selling into euro rallies

* ECB rate decision, bond buying outlook in focus as Draghi debuts

By William James and Jessica Mortimer

LONDON, Nov 3 (Reuters) - The euro rose in volatile trade on Thursday, reversing an earlier fall as political chaos in Greece called into doubt a planned referendum which had been seen threatening a disorderly default and exit from the single currency.

Greek Prime Minister George Papandreou spooked markets this week by calling for a referendum on a new rescue package but with the government on the brink of collapse, doubt over whether the vote would take place saw the euro rebound.

For some speculators, any cancellation of the referendum lowered the chances of Greece running out of cash in December and leaving the single currency -- seen by many as the worst- case scenario for financial markets.

The euro was up 0.3 percent at $1.3789, off a low of $1.3656, with traders citing buying to close out earlier bets that the euro would fall. It benefited from short covering after some Middle Eeast investors were buying at lower levels.

"It may be the case that the government falls and it looks like the elections are going to result in a coalition and potentially a deal with the troika. We could then see ourselves all the way back up at $1.40 again -- but it's still a sell on rallies," said Stephen Gallo, head of market analysis at Schneider Foreign Exchange.

France and Germany made it clear at a meeting of G20 leaders that Greece must decide urgently if it wants to remain in the euro zone, prompting investors to sell into a bounce.

"Depending on whether there is a referendum or not, I would not be surprised to see the euro trade down to $1.33/$1.34 area in the next two to three weeks," said Jeremy Stretch, currency strategist at CIBC.

"Merkel, Sarkozy and Papandreou are playing something akin to a game of poker, where they keep raising the stakes."

Some traders were speculating that an exit of the currency bloc's most-indebted country could be a reason to buy the euro.

"I can see a situation where they exit the euro zone and it's ultimately a better, more stable economy going forwards... but that's a way off," a trader said.

Others, however, were concerned about the implications for the banking sector if Greece defaulted and the difficulty of then preventing the crisis spreading, with yields on Italian bonds rising towards unsustainable levels.

On the downside, support for the euro lies at the Nov 1 low of $1.3608 and then $1.3566, the 61.8 percent retracement of its October rally.

However, given the United States has debt problems of its own and with the Japanese authorities intervening to curb yen strength, traders said the euro may gain with investors weighing who could be the biggest loser out of the three most traded currencies -- the dollar, euro and yen.

A Reuters poll showed euro volatility was set to fall in November, but the euro zone's debt crisis meant the single currency was set to remain the most volatile among other major currencies.

ECB FOCUS

The market's focus will switch later to a European Central Bank policy meeting, the first under new head Mario Draghi.

He is expected to play safe and seek to project calm rather than panic by holding off on cutting interest rates for the time being, though markets see a small risk of a surprise cut which would send the euro lower.

Money markets were pricing a 32 percent chance of a cut in rates at this meeting, with a 25 bps cut priced in for December according to BNP Paribas analysis of the Euribor futures curve.

Markets will be watching for any clues on whether Draghi stands ready to carry on, or even scale up, the ECB's bond-buying programme.

"If he hints at a bigger bond-buying programme the euro will really rally," Schneider's Gallo said.

The dollar was stuck in a narrow range against the yen, holding steady at 78.01 yen . The focus is on whether Japan will intervene if the yen starts heading higher again after Tokyo's massive yen-selling on Monday, estimated at a record 7.7 trillion yen.

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