Euro drops as debt funding fears keep investors wary

NEW YORK (Jan 4): The euro fell to its lowest level against the dollar
in nearly a week on Wednesday as a muted German Bund auction fueled
fears that important upcoming sovereign debt sales may be met by
mediocre demand.

While Germany's bond sale saw better demand
than an auction in November that had raised fears the bloc's debt crisis
was spreading to its strongest economy, rock-bottom yields kept some
investors sidelined.

France will add to the brisk start to the 2012 debt auction calendar by selling up to 8 billion euros of bonds on Thursday.

But the key test of investor sentiment comes next week when Spain and
Italy, the two countries most exposed to an escalation of the crisis,
kick off their funding campaigns.

France is seen as having a
greater risk of contagion from the euro-zone debt crisis than Germany.
Analysts said lackluster demand at the auction could increase concerns
that France will could lose its triple-A credit rating.

France
and its euro zone peers were put on review for a possible downgrade by
Standard & Poor's last month, and other ratings agencies have also
warned that France's top-grade status may be at risk.

"We are in
very risky world right now, and sentiment remains extremely fragile,"
said Brian Dolan, chief currency strategist at Forex.com in Bedminster,
New Jersey. "Euro zone bonds did not benefit from yesterday's risk-on
trade, and yields remain at unnerving levels," he said.

"The
market is prepared for a French downgrade, so a one-notch downgrade
would not be disastrous. But if they keep the outlook negative or
downgrade the debt by more than one notch that could have a more
significant impact."

The euro last traded down 0.8 percent to
$1.2946, with a session low of $1.2896, according to Reuters data.
Italy's 2012 upcoming debut bond sale will also be closely watched with
10-year yields again approaching the 7 percent level widely seen as
unsustainable.

"Economic data today was mixed and risk sentiment
has turned more bearish, aggravating pressures in the European bond
market and weighing on the euro," said Camilla Sutton, chief currency
strategist at Scotia Capital in Toronto.

"Two bond auctions
today went off reasonably well considering the environment." Portugal,
as well as Germany, sold debt on Wednesday, and its short-term borrowing
costs fell to their lowest level since April. Dolan, of Forex.com, said
the only factor inhibiting significant euro losses is a market already
extremely short and pessimistic.

"Those looking to short the
euro have likely already done so," he said. "Nevertheless, the euro
should test a low of $1.20 in the next few months as European data
confirms a recession."

Euro-zone economic data also tempered
risk appetite. The latest set of purchasing managers' indexes suggest
the region is on course for a moderate recession, even though the
composite PMI reading was slightly better than expected.

Against
the yen, the single currency was down 0.7 percent at 99.32 yen, holding
above the decade low of 98.71 hit on electronic trading platform EBS in
holiday-thin trade on Monday. The greenback was up 0.1 percent against
the yen at 76.74 with a session peak of 76.82 yen, but still not far
from the record low of 75.311 touched late last year on electronic
trading platform EBS.

"That the yen has performed this strongly
in a far from consistent risk environment, tends to refute one line of
thinking that long yen is simply a short risk 'correlation' trade,"
according to Deutsche Bank.

The most important back-story to the
yen's strong performance continues to be the unwillingness of long-term
Japanese investors to recycle the current account surplus in unhedged
form, the bank said in a research report.

The Swiss franc eased
on Wednesday after a report that European Union governments have reached
a preliminary agreement to ban imports of Iranian crude oil to the EU
but have yet to decide when such an embargo would be put in place. The
dollar last traded at 0.9416 Swiss franc, up 1 percent on the day, and
the session peak of 0.9448 franc near a one-week high.- Reuters