FOREX-Euro rises from 2-year low, but gains expected to fade

by on July 25, 2012 8:12 pm BST

Wed Jul 25, 2012 4:12pm EDT

* ECB's Nowotny sees grounds for giving ESM a banking
    * Moody's cuts outlook on EU stability facility to negative
    * Euro break below $1.20 would open test of 2010 low

    By Wanfeng Zhou
    NEW YORK, July 25 (Reuters) - The euro rose against the
dollar for the first time in six days on Wednesday after a
European Central Bank official said he could see grounds for
giving the euro zone bailout fund a banking license that would
increase its crisis fighting firepower.
    The comments from Ewald Nowotny, a member of the ECB's
Governing Council, prompted a flurry of short-covering and
helped the euro rebound from a two-year low as investors who had
bet against the single currency were squeezed out of those
    Nevertheless, many analysts said the downtrend for the euro
remained intact. While a banking license would enable the
bailout fund to borrow unlimited central bank money to fight the
debt crisis, it is still just an idea and one that may not come
to fruition given other ECB officials' opposition.
    "Just the prospect that you can see an alternative solution
to help prop up Europe is being viewed as a positive," said
Gareth Sylvester, senior currency strategist at Klarity FX in
San Francisco.
    "The reality is that it's simply an idea and nothing more
than that just yet," he said. "The actual EU constitution would
have to be amended to give (the European Stability Mechanism)
those powers and it has to be ratified by all member states."
    The euro hit a session high of $1.2169, recovering
from a two-year low of $1.2040 set on Tuesday. It was last up
0.8 percent at $1.2154.
    The euro garnered an added boost after Spain and France said
on Wednesday in a joint statement that for stability in the euro
area, the adoption of a single supervisory mechanism for the
bloc's banks is needed by the end of this year..
    Against the yen, the euro rose as high as 95.20 yen
, having carved out a 12-year low of around 94.11
earlier in the week. It was last up 0.8 percent at 95.01 yen.
    The dollar was little changed at 78.15 yen.

    Sentiment toward the euro remained bearish given spiraling
Spanish borrowing costs that have fueled concerns the country
will need a full sovereign bailout. 
    A break below support at the psychologically important level
of $1.20 would open up a test of the 2010 low of $1.1875.
    "It's going to be a slow grind down towards that - two steps
backward and one step forward," said Fabian Eliasson, vice
president of currency sales at Mizuho Corporate Bank in New
York. "Volatility is just too high to see it going straight
    Yields on Spanish debt have jumped since last week when the
region of Valencia said it would need financial help from
Madrid, with investors concerned other indebted regions will
also seek aid. 
    As speculation grew that Spain, the fourth-largest economy
in the euro zone, may need a full-scale sovereign bailout,
investors were worried that Europe's bailout fund would have
little money left to support other troubled countries including
Greece, Italy and Portugal.
    Delivering yet more bad news for Europe, Moody's changed the
outlook on its provisional top-notch rating for the European
Financial Stability Facility to negative, while Egan-Jones on
Wednesday cut Italy's sovereign rating.
    Moody's earlier in the week changed its outlooks for
Germany, the Netherlands and Luxembourg to negative. All three
are guarantors for the European Financial Stability Facility,
with Germany holding the largest share at just over 29 percent.
    The U.S. dollar briefly pared losses against the euro after
data showing new U.S. single-family home sales in June fell by
the most in more than a year dented risk appetite. But the
impact was short-lived as the data fueled expectations of
further stimulus from the Federal Reserve.