Euro gains on ESM comments but underlying weakness remains

Wed Jul 25, 2012 8:24am EDT
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NEW YORK (Reuters) - The euro rallied against most major currencies on Wednesday, recovering from a two-year low against the dollar after a European Central Bank policymaker said he could see grounds for giving the euro zone bailout fund a banking license.

The comments from Ewald Nowotny prompted a flurry of short-covering as the euro jumped higher, with some investors who had bet against the single currency being squeezed out of those positions.

But many analysts said the move was overdone and predicted further weakness ahead.

"A banking license would allow the European Stability Mechanism to leverage its balance sheet and give the fund far greater ability to act in the euro zone credit markets, amplifying its power as backstop for European Union member sovereign bonds," said Boris Schlossberg, managing director of FX strategy at BK Asset Management. The euro/dollar "is grossly oversold and due for some upside relief."

The euro hit a session high of $1.2169 and was last up 0.6 percent at $1.2131.

A banking license would give the European Stability Mechanism more firepower to fight the debt crisis but analysts said the market may have put too much emphasis on the comments, given ECB opposition to date, and investors would likely sell into the euro's rally.

"The market is desperate and jumping on anything that even looks remotely positive," said Geoff Kendrick, currency strategist at Nomura.

It touched a two-year low on Tuesday against the dollar when some EU officials said Greece was unlikely to be able to pay what it owes and further debt restructuring is likely to be necessary.

The outlook remains deeply negative given spiraling Spanish borrowing costs that have fueled concerns the country will need a full sovereign bailout.   Continued...