Analysis: Poor German auction spells tough times for euro

Thu Nov 24, 2011 2:11pm EST
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By Nia Williams

LONDON (Reuters) - Weak demand at a German debt auction suggests investors are starting to shun even the euro zone's strongest economy, which could trigger more losses in the shared currency as many shift from euro-denominated assets to safe havens outside the region.

As Italian, Spanish and even French yield spreads have blown out to record levels in recent weeks, the trend has been for portfolio flows to switch into German Bunds, resulting in no foreign exchange outflows from the euro zone.

Those flows, combined with talk of repatriation of capital by euro zone banks desperate to shore up their balance sheets as money markets seize up, have been cited as reasons behind the euro's recent resilience around $1.34.

But that appears to be changing and on Thursday the euro slid to a 7-week low at $1.3316 on trading platform EBS.

Germany sold barely half the bonds it put up for auction on Wednesday, when a buyers' strike against the low yields on offer was fueled by fears that Berlin could not remain immune from the crisis engulfing its heavily indebted euro partners.

In a sign that investors are cutting exposure to the euro zone as a whole, 10-year Bund yields converged with UK gilts for the first time in 2-1/2 years.

Normally, positive yield differentials would be considered a reason to buy the euro. But analysts said investors are now more likely to sell the shared currency because of fears that Germany

may be forced to underwrite the fiscal excesses of weaker euro zone economies. Those worries could push the euro to $1.25 or lower by early next year, some analysts say.   Continued...