* Worries about Greece euro exit, banking sector hurt euro
* Euro hits 4-month low vs firmer dollar, 3-month low vs yen
* Spain’s Bankia shares tumble, talk of possible downgrades
By Gertrude Chavez-Dreyfuss
NEW YORK, May 17 (Reuters) - The safe-haven yen posted sharp gains against the euro and dollar on Thursday on concerns about banks in Spain and Greece, chances of contagion if Greece leaves the euro and disappointing U.S. economic data.
The Japanese currency earlier jumped to a three-month high against both the dollar and euro as talk of possible Spanish bank downgrades pushed European equities sharply lower and kept the single currency under pressure.
The euro had also fallen to a four-month low versus the dollar but recovered by early afternoon to trade slightly higher on the day. Troubles in Greece and Spain added to concern the euro zone lacks a firm plan to deal with its debt problems.
“We ... view the risk skewed significantly to the downside in euro/dollar over the next two months,” said Jens Nordvig, global head of currency and fixed income strategy at Nomura Securities in New York.
“The second round of the Greek election may well put the actual exit process in motion, and we would likely see euro/dollar test $1.20 in that scenario.” Greece will hold fresh elections on June 17 after last weekend’s polls ended in a deadlock.
The euro dropped to 100.54 yen, the lowest since February 7. It was last at 100.59, down 1.5 percent.
The dollar also fell sharply against the yen, sliding to 79.12 yen, its weakest level since February 17. By late afternoon trading, the greenback was down 1.3 percent at 79.24 yen.
The euro dropped to $1.2665, its lowest level since mid-January, past stop-loss sell orders below $1.2680 and on course for a test of its 2012 low of $1.2623, according to Reuters data. It last traded at $1.2694, down 0.2 percent.
“The fact that so many are talking of a possible Greek exit from the single currency, including sober central bankers, shows that the threat to Greece’s continued membership of the eurozone is a real one,” said BNP Paribas in a research note.
The bank added that shorting the euro against the dollar remained the best trade for the pair. It has further revised lower its target on euro/dollar to $1.2625 from $1.28 previously.
Shares in Spanish lender Bankia fell more than 20 percent following a report in the El Mundo newspaper its customers had pulled over 1 billion euros from accounts over the past week.
This followed news on Wednesday the European Central Bank had stopped providing liquidity to some Greek banks because they had not been successfully recapitalised.
Investors were increasingly worried Greece could leave the euro following a second election in June. A poll, however, showed Greece’s conservative New Democracy party, which backs the country’s international bailout, has overtaken the anti-bailout radical leftist SYRIZA in popularity.
The euro did get a bid after the release of an index of business conditions in the U.S. Mid-Atlantic region which came in well below expectations but the impact was fleeting and more due to dollar weakness.. The dollar, meanwhile, extended losses against the yen after the Philadelphia Fed data.
The single euro zone currency again swung back to losses after an IMF official said the European Central Bank had room for further easing, given a weakening economy, and for further unconventional policy measures..
That said, Anthony King, managing director of investment grade fixed income at PineBridge Investments in London, thinks the euro is likely to have some support at the year-to-date lows around $1.26, “but conceivably, it opens up back to the 2010 lows around $1.1875.”
Higher yields for Spain at an otherwise well-received bond auction on Thursday reinforced concerns its borrowing costs may become unsustainable.
Data on Thursday showed Spain’s economy contracted by 0.3 percent in the first quarter, putting it firmly in recession.
The dollar index, meanwhile, climbed to a four-month high of 81.682 as investors sought safety.
Some said the euro may rebound as the market has priced in much of the risk surrounding Greece. Most predicted, however, that the euro’s slide will continue.
“We wouldn’t be surprised to see the euro/dollar going back to $1.30 and stay within the same range within three months - we are pretty much at the bottom of the range,” said Pierre Lequeux, head of currency management at Aviva Investors in London.
“Perhaps it could drop to $1.25 if Greece is given the red card by Europe,” he said. He added, however, that a Greek exit may be priced in already and pointed out that the euro has traded in a relatively narrow range since January.
Traders’ skittishness toward the euro was visible in options markets, where one-month euro/dollar implied volatility traded close to the 2-1/2-month high hit on Wednesday at 11.30 percent. Meanwhile, the cost of protecting against a euro decline rose further to 2.3 percent on Thursday from 1.5 percent at the beginning of the month.