* Euro plunges as investors spooked by Cyprus news
* Yen gaps higher as speculators caught short; USD follows
* Focus on Cyprus parliament vote, peripheral bond yields
By Sophie Knight and Lisa Twaronite
TOKYO, March 18 (Reuters) - The euro dived and traders squeezed the yen higher in Asian trade on Monday as news that Cyprus’ bailout plan involves a tax on depositors was taken as a dangerous precedent that could ultimately trigger bank runs elsewhere in the euro zone.
Breaking with previous EU protocol that citizens’ savings are sacrosanct, euro zone finance ministers demanded on Sunday that Cypriots pay up to 9.9 percent of their deposits in exchange for a 10 billion euro ($13 billion) bailout, prompting a run on cash.
“It was a big shock to hear that they will tax savings, and the worry is that this could impact larger countries like Spain or Italy. It remains to be seen how European and U.S. markets will react,” said Kenichi Asada, manager of forex at Trust & Custody Services Bank.
The common currency sank as low as $1.2888 in early Asian trade, its lowest since Dec. 10, before steadying around $1.2903, or 1.3 percent below late levels in North America on Friday.
Against the yen, the euro tumbled 2.1 percent, briefly breaking through support at 121.681, its 55-day moving average, which analysts said could herald a deeper correction. It last bought 121.860 yen.
The common currency also lost ground on the Swiss franc to 1.2186 francs, from around 1.2275.
“People were already cutting their exposure to riskier assets and this has been a further catalyst for those who are long to cut back on them,” said Takumi Nomura, senior trader at the Bank of Tokyo-Mitsubishi UFJ.
The yen shot higher across the board as speculative sellers were caught badly short of the currency, and had to quickly unwind carry trade positions.
Borrowing in the Japanese currency to buy higher yielding assets has been a heavily-favoured trade in recent weeks on expectations of more aggressive easing steps from the Bank of Japan.
The dollar was shoved as low as 93.450 yen in volatile trading before dawn in Tokyo, marking its lowest since March 6 and moving away from a 3-1/2 year peak of 96.71 struck on March 12. Later on Monday, it firmed to 94.470 yen.
Market participants said it would not be unusual for the yen to firm as far as 90 against the dollar. Last week, the price of yen puts, bets that the yen will weaken, suddenly fell relative to yen calls, bets that the currency will gain. Asada of Trust & Custody Services said there was a cluster of such options around 93 yen to the dollar.
The U.S. dollar was up 0.6 percent on late Friday levels against a basket of currencies at 82.733 on Monday.
An improving U.S. economy has underpinned the greenback in recent weeks. The country’s manufacturing sector was shown to be growing by data released on Friday, although consumer sentiment faltered to its weakest in over a year and inflation picked up.
Turbulent early trade shook the Australian dollar down by almost two full yen to a low of 97.74 yen, its lowest since March 8, before it firmed slightly to 97.83.
Euro zone leaders and Cyprus agreed on the weekend that depositors should be taxed up to 10 percent - 6.7 percent on amounts below 100,000 euros and 9.9 percent on savings above that - to raise 5.8 billion euros so the island country could be eligible for an international bailout.
Cyprus postponed a parliamentary vote on the measure to Monday as the country was discussing with lenders the possibility of changing the levy to 3.0 percent for deposits below 100,000 euros, and to 12.5 percent for those above that, sources said.
Taxing depositors would be a radical change from usual practice, and would give depositors in other debt-ridden countries an incentive to shift their money to banks in EU countries with lower financial system risks, such as Germany.
Some strategists expected limited fallout from the move in the longer term, but nonetheless recognised it as a clear short-term signal to sell the euro.
“It’s short-term negative for risk, the euro and dollar-yen but we think it shouldn’t last too long... The broad trend for yen weakness is still intact despite the near-term upside,” said Bill Diviney, currency strategist at Barclays in Tokyo.
“Our view is that ultimately the backstops are in place to prevent any more contagion. The ECB’s policies and also banks are in a much better position than they were last year,” he added.
Analysts said signs of contagion could be signalled by widening in bond spreads of peripheral European countries.