FOREX-Euro off lows, but little respite seen

Anirban Nag, 1:15, Wednesday 26 May 2010

* Euro steadies after rebound from lows

* But outlook bearish with players looking to sell at upticks

* Tighter funding costs to drive demand for USD

SYDNEY, May 26 (Reuters) - The euro was off lows on Wednesday, but there was little respite in store for it as investors look to sell on every uptick and sentiment bearish on concerns about the health of the euro zone's banking sector.

Signs of tighter funding, with costs for banks to borrow dollars in the interbank market soaring to 10-month highs, is likely to drive investors to the relative safety of the U.S. dollar and away from riskier assets and currencies, traders said.

U.S. two-year swap spreads , a key gauge of financial system stress, also widened to one-year highs on Tuesday. [ID:nLDE64O1MP]

The Bank of Spain on Saturday said it had taken over a small savings bank, CajaSur. Analysts said the bailout highlighted weakness in the European banking sector and heightened worries that more banks in the euro zone may need to be bailed out. That is likely to see more investors fleeing the euro.

In Asian trade, the euro was down 0.3 percent at $1.2335, staying above Tuesday's low of $1.2177 which was not far from a four-year low of $1.2143 struck last week.

The euro has lost over 7 percent against the dollar so far this month and is heading for its biggest monthly fall since January 2009 at current prices.

The U.S. dollar index , which tracks the greenback against a basket of six currencies, was down at 86.59. Against the yen, the dollar was higher at 90.44 yen from 90.18 yen late in New York on Tuesday.

Against the yen, the euro was at 111.44 yen, recovering from around 108.85 yen -- its lowest since late November 2001 -- struck on Tuesday. Investors generally flock to the yen and the U.S. dollar when risk aversion and volatility spikes.

"The best hope for stability will come when cyclical exposure has been wound down, but the latest IMM and Japanese retail data suggest that these liquidations have further to run," JP Morgan said in a report.

JP Morgan said latest data from the Commodity Futures Trading Commission show long positions in the Australian dollar and the and the Mexican peso have fallen by two-thirds but for the Canadian dollar by only half. Also, Japanese margin longs in the yen crosses were near all-time highs at the start of the week.

All of which suggests the recent sell-off in growth-linked currencies was likely to run further. Tensions on the Korean peninsula are also likely to keep traders away from the Australian dollar which is hugely leveraged to the Asian growth story.

The Aussie dollar was steady at $0.8264, having earlier rallied from 10-month lows against the U.S. dollar. (Editing by Ed Davies)