May 9, 2012 / 1:31 AM / 6 years ago

Euro at 3-1/2-month low as debt crisis fears rise

NEW YORK (Reuters) - The euro dropped against the dollar to a 3-1/2-month low on Wednesday, falling for the eighth straight session on concerns that political turmoil in Greece threatens its rescue deal and as fears rise about the risks posed by Spain’s banks.

Leftist leader Alexis Tsipras gave up his attempt to form a new government on Wednesday, pushing Greece closer to its second election in a few weeks, after voter rejection of an EU/IMF bailout plunged the country into crisis.

Last Sunday’s election, in which voters vented their rage against mainstream parties over debt-cutting measures imposed in exchange for the bailout, has caused deep political deadlock and brought European threats to eject Greece from the euro.

The latest development increased the possibility that the Greek bailout deal remains viable but the drawn out uncertainty has done little to allay investor fears that the deal could still fall apart, raising the specter of Greece being forced out of the euro.

The euro also hit a two-and-a-half month trough versus the safe-haven yen as a jump in Spanish bond yields above 6 percent - one point away from levels deemed unsustainable - showed that investors were wary of the rising costs of fixing the country’s banks, fueling fears the debt crisis could worsen.

“This is a continuation of a trend that has prevailed over the past week, with Greek political disarray likely to be a drag on the euro for the foreseeable future,” said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington, D.C.

“The rise in Spanish bond yields is adding to the bearish tone and is providing investors with yet another reason to distance themselves from the single currency.”

The euro fell as low as $1.2910, its lowest since January 23, before paring losses to last trade at $1.2936, down 0.5 percent on the day.

An employee of foreign exchange trading company looks at a computer screen in Tokyo May 7, 2012. The euro tanked on Monday, breaking below its well-worn range from the past three months against the dollar after elections in Greece and France raised fresh concerns that the euro zone's hard-earned bailout and austerity steps could fall apart. REUTERS/Yuriko Nakao

Against the yen, the euro was at 103.03 yen, down 0.8 percent, after hitting a low of 102.73, its lowest since February 16.

In France, President-elect Francois Hollande has advocated an approach to tackling the debt crisis centered more on growth, which may create tensions with Germany’s insistence on fiscal austerity.

A bias against the euro was firmly evident in the options market, with demand for euro puts, or bets on the currency’s decline, rising this month.

A foreign exchange trader looks at a television showing French socialist Francois Hollande celebrating his victory in France's presidential election at a foreign currency trading company in Tokyo May 7, 2012. The euro tanked on Monday, breaking below its well-worn range from the past three months against the dollar after elections in Greece and France raised fresh concerns that the euro zone's hard-earned bailout and austerity steps could fall apart. REUTERS/Yuriko Nakao

Three-month euro/dollar risk reversals were trading at -3.05 vols on Wednesday from -2.2 vols on May 1 with the clear bias to euro puts. Implied volatility has also risen, with three-month euro/dollar options at 10.7 percent versus 9.45 percent at the start of the month.

“In the next four weeks we should know who is controlling Greece, whether or not it runs out of money or chooses to adhere to its bailout terms and how the Spanish government plans to sort out its banking sector,” said Kathleen Brooks, research director at FOREX.com.

“There are high levels of market risk associated with all of these events, which we believe is euro negative.”

A souring in investor appetite for risk gave broad support to the low-yielding yen.

“The safe-haven flows into Treasuries depressed yields, which along with the yen’s safe-haven status is a key reason why it is higher today,” said Western Union’s Manimbo.

The yen hit a two-and-a-half-month high versus the dollar at 79.41 yen. The dollar was last at 79.63, down 0.3 percent on the day.

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