Tuesday, 27 December 2011

FOREX-Euro steady but Italian auction risk looms

Tue Dec 27, 2011 7:02am EST
By Naomi Tajitsu

LONDON, Dec 27 (Reuters) - The euro held in sight of an 11-month low against the dollar on Tuesday and was at risk of more selling if Italy struggles to sell government debt later in the week, highlighting how the euro zone debt crisis has worsened.

The dollar was a touch weaker versus a basket of currencies, but rates in general were little changed in extremely thin trade. UK markets were closed on Tuesday.

The euro traded up 0.1 percent at $1.3075, with the upside seen limited by options expiries at $1.3100 later in the day. A fall below $1.2945, a level touched earlier in the month, would take it to the weakest level since January.

Despite the spread of the euro's problems with government debt over the past year, the single currency is down only 2.3 percent so far in 2011, partly due to reserve diversification flows away from the dollar by central banks.

Speculation that the U.S. Federal Reserve may consider another round of quantitative easing next year has also put the greenback under pressure, supporting the euro.

But with little economic data and few events scheduled for the last week of 2011, investors are focused on Italian auctions of three- and 10-year government bonds on Thursday.

Rome's borrowing costs have surged in recent months to put yields around levels considered by many in the market to be unsustainable and raised speculation that the country may require a bailout.

Analysts said that even if investors flock to the longer-dated bonds, the euro would face selling pressure if yields climb higher after the auction.

"I think there could be some downside risks for the euro. (Thursday's auction) will be more of a test of the market, given that the bonds auctioned are longer maturities," said Sverre Holbek, currency strategist at Danske Bank in Copenhagen.

"A further rise in Italian yields should almost certainly be euro negative, and thin liquidity may exacerbate the move."

Any verdict from ratings agencies on the health of euro zone countries - speculation has grown about a downgrade to the credit ratings of sovereigns including France - could also put the single currency under more selling pressure.

The dollar slipped 0.15 percent to 79.811 versus a currency basket, but hovered in range of 80.730 hit in mid-December, its strongest since the start of the year.

Against the yen, the U.S. currency was down 0.2 percent at 77.82 yen. The pound edged up 0.1 percent to $1.5647.

Some market players said U.S. consumer confidence data due at 1500 GMT may help lift risk appetite and support perceived riskier currencies against the safe haven dollar if it surprises to the upside. Forecasts are for a reading of 58.3 in December, up from 56.0 the previous month.


Many expect the euro to stay under pressure in the near-term, as reflected in the consistently high level of bets among speculators that the single currency will weaken more.

These have piled up in past months, leaving them around record high levels as of last week according to the latest IMM data on speculator positioning.

Analysts at Citi said this reflected a bias among investors to shun the euro and other currencies perceived to be higher risk as 2011 winds down, particularly given difficult trading conditions this year.

In a note, they said this would keep trade subdued in the last trading days of the year, in contrast to some other years when currency movements, particularly versus the dollar, have become volatile as investors close positions at the last minute.

"The tactical implication is that in the final trading days of the year positioning may present less of a risk for volatility than commonly perceived," they said.

However, some in the market see the risk that the euro may initially climb on strong Italian auction results if a resulting slide in Italian yields prompt investors to cut back on those short euro positions.