May 23, 2012 / 12:00 PM / 5 years ago

FOREX-Euro drops to 21-month low as break up risks mount

5 Min Read

* Euro hits 21-month low vs dollar before EU summit

* Dollar index hits highest since Sept 2010, yen firmer

* Growth-linked currencies take a hit

By Anirban Nag

LONDON, May 23 (Reuters) - The euro fell to a 21-month low against the dollar on Wednesday as investors added to bearish bets on growing concerns about a chaotic Greek exit and widespread scepticism about the outcome of an EU summit due later in the day.

EU leaders are expected to discuss growth-boosting measures but are not expected to produce any plan that would restore optimism among investors, especially given Germany remains strongly opposed to joint euro bonds.

Investors are doubtful that the leaders will come up with any measures to calm fears that have grown since an inconclusive Greek election earlier this month left the country on the path to bankruptcy and a possible exit from the euro zone.

The euro fell to $1.2615 on trading platform EBS, dropping below the 2012 low of $1.2624 set in January to mark its lowest since August 2010 as real money investors, corporates and macro funds stepped up euro selling.

Traders reported an option barrier at $1.2600 with stop-loss orders below $1.2575. It was last trading at $1.2650, still down 0.2 percent on the day, with option expiries at $1.2650 and $1.2725-30 likely to check gains.

"The euro's downtrend is entrenched and we think there are too many risks of potentially nasty outcomes in the euro zone, especially with regard to what will happen to Greece," said Ned Rumpeltin, currency strategist at Standard Chartered.

"We expect the euro to be at $1.25 by the end of the quarter, but today's close will be very important in the short term. If there is a bounce, we will see the euro consolidating a bit more, but if we end near today's lows, then we should see it weaken further. In any case the euro is a sell on a rebound."

Fears that Greece may have to leave the euro grew after Dow Jones earlier quoted former prime minister Lucas Papademos as saying Greece had no choice but to stick with a painful austerity programme or face a damaging exit from the euro zone.

His clarification in a television interview later offered little respite to the struggling euro, which has shed 4.5 percent against the dollar so far this month.

Apart from concerns about political uncertainty in Greece, investors remain edgy about the potential for the crisis to spread and troubles in the Spanish banking sector.

"From a medium term perspective, the risk reward is a significant downside for the euro from current levels," said Howard Jones, advisor at RMG Wealth Management.

"There is considerable risk things in the euro zone can unravel, and that of contagion. It all points to a weaker euro and maybe euro zone governments will welcome that."

Dollar Index at 20-Month High

Growing worries about a possible exit by Greece supported safe-haven assets and currencies. Reflecting those fears, European powerhouse Germany sold two-year government debt on which it will pay no interest, its first zero-interest issue with such a maturity.

Safe-haven currencies like the U.S. dollar and the yen remained the key beneficiaries from the euro zone crisis. The dollar index, which measures the dollar's value against a basket of major currencies, rose to 81.913 - a 20-month high.

The euro fell to a 3-1/2 month low against the yen of 100.16 yen on EBS while high-yielding currencies like the Australian and New Zealand dollars fell sharply. The U.S. dollar also advanced to a four-month high against the Swiss franc.

Against the yen, however, the dollar fell after the Bank of Japan kept its monetary policy unchanged.

While the decision was in line with most expectations, a few participants had been speculating the central bank could follow up with new easing steps after its monetary easing in April.

The dollar was down 0.7 percent versus the yen to 79.39 yen, with the Japanese currency recovering from falls on Tuesday after Fitch downgraded Japan's sovereign credit rating.

"Dollar/yen has been helped most by the rise in U.S. two-year government bond yields, which may well drift lower if euro zone problems intensify, which would no doubt drag the dollar lower against the yen too," said Derek Halpenny, European head of global market research at Bank of Tokyo Mitsubishi.

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