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Euro resumes slide as doubts swirl over aid plan

NEW YORK (Reuters) - The euro fell on Tuesday as concerns about the euro zone’s ability to contain a debt crisis blunted initial enthusiasm after this week’s $1 trillion rescue package.

The euro retreated from Monday’s high near $1.31, at one point falling below $1.27 as investors wondered whether weaker euro zone economies can deliver the drastic spending cuts and tax increases needed to get their fiscal houses in order.

“Markets aren’t buying the story. It’s clear that the markets remain very concerned about the fiscal outlook for Europe,” said Mike Moran, senior currency strategist at Standard Chartered Bank in New York. “Clearly, the near-term outlook is one of skepticism for the euro.”

The euro traded at $1.2732, off a session low of $1.2667 but still down 0.4 percent on the day. Last week, the euro fell to a 14-month low around $1.2510, and Moran still expects it to hit $1.15 by the third quarter.

Against sterling, the euro fell 1.2 percent to 85.05 pence. Britain’s currency also rose 0.9 percent to $1.4975 as speculation grew the Conservatives were close to forming a new government with the smaller Liberal Democrats, with Labour left in opposition.

The dollar rose 0.3 percent to 92.99 yen. Traders said the yen was helped by Japanese exporter buying. The euro fell 0.7 percent to 118.45 yen.

The euro pared losses against the Swiss franc after the Swiss National Bank chairman said he was committed to fighting deflation by preventing excessive franc strength. The euro was still down 0.5 percent on the day at 1.4115 francs.

NOT ENOUGH

Europe’s debt trouble showed signs of spreading in recent weeks as investors drove up borrowing costs for countries such as Portugal, Spain and Ireland that also face sluggish growth and high deficits.

Many worry the rescue plan, which would disburse emergency aid to countries in financial trouble, won’t be enough. Nout Wellink, a member of the European Central Bank’s governing council, told Dutch newspaper NRC Handelsblad the plan is a safety net and won’t work unless countries cut debt levels.

The aid package “is just another way of delaying perhaps the inevitable,” said Shaun Osborne, chief FX strategist at TD Securities in Toronto. “It pushes the debt problems further down the road.”

On Monday, Moody’s Investors Service said it may still downgrade its credit rating on Portugal. It said Greece’s rating could fall to junk grade.

Analysts said the European Central Bank’s decision to buy government bonds could hurt the euro later this year as it further dampens chances of interest rate hikes in the euro zone. Most economists at major U.S. banks expect the Federal Reserve to lift U.S. interest rates in 2011.

The options market was showing a clear bias toward further euro losses. The one-month risk-reversal was trading at 3.00 for euro puts versus 2.65 on Monday, moving beyond the previous record seen at the peak of the crisis surrounding Lehman Brothers’ 2008 collapse.

But Axel Merk, portfolio manager for the $500 million Merk Hard Currency Fund in Palo Alto, California, said he remains bullish on the euro.

“The euro zone is finally getting its act together. It is moving toward a more solid fiscal management and there is a sense that problems are being addressed,” he said.

“At the end of the day, investors will recognize that the ones in trouble are the fringe countries and not the entire euro zone. The euro zone will come out stronger in the long run.”

Reporting by Steven C. Johnson and Wanfeng Zhou; Additional reporting by Gertrude Chavez-Dreyfuss

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