TOKYO: The euro was capped in Asia on Thursday after two days of gains on short covering as market players looked to Italy's bond auction later in the day amid concerns external support may become necessary for the euro zone's third-largest economy.
The euro rose in the past two days as traders pared extremely bearish positions ahead of Sunday's crucial Greek election and after disappointing US retail sales data weighed on the dollar.
Still, the currency remains under heavy pressure with a sharp rise in German bunds in the past few days raising worries that even Germany can no longer shoulder the snowballing cost of the debt crisis if Italy has to ask for help.
“The fact that bunds were sold for two days in a row is deeply disturbing. Investors may be starting to cut exposure to the entire euro area. And if you look at what's happening in Europe, it's hard to think they won't do that,” said Daisuke Uno, chief strategist at SMBC.
The euro last stood at $1.2570, having risen as high as $1.2611 on Wednesday but a three-notch downgrade of Spain's credit ratings by Moody's was enough to bring the short-covering to an end.
“This is now the lowest rating among the three main agencies for Spain. This may augment the recent stress in the European bond markets today and likely put the Italian bond auctions today under greater scrutiny,” analysts at BNP Paribas wrote in a note.
Italy is due to sell up to 4.5 billion euros of bonds later on Thursday and its borrowing costs are expected to rise sharply. The bond sale comes a day after the yield on its one-year notes hit a six-month high of 3.97 per cent at a debt auction.
Saddled with the world's fourth-largest debt pile and a shrinking economy, Italy is again in the markets' firing line as reforms undertaken by its unelected government have stalled and no clear strategy has emerged in Europe to halt the broader debt crisis.
EXIT FROM EURO?
Fears of a euro zone break-up could intensify if Greek elections on Sunday set Athens on the road to an exit the single currency bloc.
The election outcome is too close to call for now. Syriza, the leftist party opposed to austerity measures, and the New Democracy group, which backs Greece's international bailout, are locked in a tight race.
“If the former coalition parties win the election, the euro could rise 300 to 400 pips. But it will be capped below $1.30, given that unlike before May (when the euro traded above $1.30), there are worries about Spain and Italy now,” said Minori Uchida, chief currency analyst at the Bank of Tokyo-Mitsubishi UFJ.
“On the other hand, if the Syriza wins, the euro is likely to fall to a low hit earlier this month of $1.2280. But I doubt the euro will test new lows just because of that. The market will see how they will negotiate with the troika,” Uchida said, referring to the European Commission, the European Central Bank and the International Monetary Fund.
Against the yen, the euro stood at 99.85, not far off an overnight peak around 100.11, with Japanese exporters bids lined up above 100 yen.
The dollar fetched 79.45 yen, off Monday's high of 79.92 yen, again with Japanese exporters' offers above 80 yen capping the US currency.
Commodity currencies had a tougher time with the Australian dollar once again retreating from parity against the greenback. It last stood at $0.9960.
The New Zealand currency slipped to $0.7750 from a one-month high of $0.7808 hit on Wednesday.
The kiwi lost a few pips after the Reserve Bank of New Zealand said a weak economy and an uncertain global outlook meant rates need to stay at record lows.
As expected, the RBNZ kept rates unchanged at 2.5 per cent for a 10th straight meeting.
“We didn't think the Reserve Bank would cut rates, but that they would be ready to react strongly if we did get quite a serious development in the European debt crisis,” said Nick Tuffley, chief economist at ASB Bank.
“They are waiting to see what that outcome will be. If Europe continues to muddle through, we don't believe rates will go up until March next year at the earliest.”
