Euro at two-month low over contagion fears

City A.M. Reporter

EURO has fallen to two-month lows against the dollar today as investors looked past the Irish rescue package to debt problems in other peripheral eurozone economies and sold the currency on any bounce.

European Union finance ministers endorsed an €85bn (£72bn) rescue package for Dublin and approved outlines of a permanent crisis-resolution system that could make private bondholders share the burden of restructuring sovereign debt after 2013.

Sentiment remained fragile with a sale of Italian bonds meeting lukewarm demand and highlighting investors' unease towards euro zone debt and the risk of contagion.

A key question is whether the EU has done enough to stop the crisis spreading to euro zone members such as Portugal and Spain – a problem left unresolved after Greece was bailed out in May.

"The euro remains a sell on rallies and any relief is temporary," said Ankita Dudani, G-10 currency strategist at RBS Global Banking.

"Ireland is taken care of but now the question is whether Portugal needs help this year or the first thing next year. And then you have Spain."

Many traders think the European Financial Stability Facility, a joint EU-IMF fund created in May, may not have enough funds to support Spain if it needs help.

The euro was down 0.56 per cent at $1.3172, having fallen to $1.3166, its lowest since Sept. 21.

It fell through its 100-day moving average on Friday, a bearish signal, and the next target is its 200-day moving average currently at $1.3129.

Euro/dollar implied volatilities extended a recent ascent, reflecting nervousness about the single currency. One-month vols rose to 14.55 per cent from 13.60 on Friday, while risk-reversals increasingly bid for the downside.

The one-month 25-delta was trading around 2.0 for euro puts versus 1.85 on Friday.

Ireland said the emergency loans would run for an average of 7.5 years, with an interest rate of around 6 per cent.

Many analysts say markets are still likely to turn on Portugal and Spain, seen as the eurozone's next weakest links.

"It is going to be difficult to ringfence Ireland," said Tom Levinson, FX strategist at ING. "The euro will continue to struggle in a week when we can expect some decent U.S. data."

Another source of uncertainty is a lack of details on a Franco-German proposal to make private bondholders share the burden of losses on sovereign debt restructuring.

"The difficulty for the market is to allow itself the luxury of letting these developments get traction in a currency market where buying the euro is still akin to catching the falling knife," Daragh Maher, deputy head of global foreign exchange research at CIB wrote.

Analysts said the market would be on the lookout for whether ECB policymakers, meeting on Thursday, would go ahead and remove some of the emergency measures put in place earlier this year.

While some analysts say the Irish package will reduce Irish banks' need for ECB funding, RBS's Dudani said euro zone banks were still grappling with funding problems and the emergency measures were needed.

The euro's losses helped the dollar index to its highest in two months. It rose to as high 80.653, up 0.3 per cent for the day.