Euro lower as momentum fades, sentiment fragile

Anirban Nag, 1:07, Tuesday 25 May 2010

SYDNEY (Reuters) - The euro was under pressure on Tuesday, as a recent short covering bounce faded and concerns about a broader contagion to the banking sector from the sovereign debt crisis in the euro zone drove investors to sell.

The euro slipped to $1.2346 in Asian trade from around $1.2376 late in New York on Monday when it lost over 1.5 percent. It appeared to have lost most of its hard-fought gains made last week when it posted its first weekly rise against the greenback in six weeks. It had risen to as high as $1.2672 late last week.

Funding conditions for banks have also been tightening, with firms in the United States increasingly reluctant to deal with firms with large exposure to Europe, a move analysts say reflects growing risk aversion and a preference for safe-haven assets like U.S. Treasuries.

"Investors are selling into every rally in the euro," said Jonathan Cavenagh, currency strategist at Westpac. "Worries about the euro debt crisis are showing signs of spilling over to the banking sector with funding costs rising, albeit from very low levels. All this will only see more demand for U.S. dollars."

The U.S. dollar and the Japanese yen tend to gain when there is a spike in volatility and loss in risk appetite. Indeed, the dollar index was up at 86.51.

The dollar/yen was steady at 90.22 yen, having gained over 0.3 percent on Monday.

But the euro was lower against the yen, at 111.27 yen, down from 111.78 yen late on Monday in New York when it lost over 1 percent. It has steadily lost ground this week as European banks and Asian central banks have stepped up selling.

Weighing down on sentiment towards the euro was news that Spain's central bank on Saturday took over savings bank CajaSur following the failure of its planned merger with another regional lender.

Although CajaSur is relatively small, analysts said the bailout highlighted weakness in the European banking sector.

The U.S. dollar was also helped by decent economic figures. Data released on Monday that showed U.S. existing home sales rose more than expected in April.

Traders said with liquidity in the forex market showing signs of drying up, investors are likely to scramble for safe-haven dollars. That is likely to keep the downward pressure on growth-linked currencies like the Australian dollar.

The Australian dollar was down at $0.8226, from around $0.8280 late on Monday.

(Editing by Balazs Koranyi)