LONDON (Reuters) - The euro bounced from near two-year lows against the dollar on Wednesday, after the European Commission called for sweeping reforms to restore investor confidence, but gains were likely to be fleeting on growing concerns about Spanish banks.
The European Commission said the euro zone should move towards a banking union and consider eurobonds and the direct recapitalization of banks from its permanent bailout fund as it laid out year-long recommendations in a report.
The euro rose to as high as $1.24684 from a 23-month low of $1.24241 on trading platform EBS after the comments, but analysts said any bounce would only provide a fresh opportunity to sell the common currency.
“We will sell into this bounce as these proposals will take a long time and will entail changes to the treaty,” said Geoffrey Yu, currency strategist at UBS.
Earlier the euro fell to its lowest since early July 2010, as real money and institutional investors stepped up sales of the currency. Their selling gathered pace as concerns grew about Spain’s ailing banking sector and soaring borrowing costs, and after Italy was forced to pay dearly to sell debt.
The euro was seen highly vulnerable to further falls, with many analysts looking for a drop towards $1.20.
Concerns are growing that Spain may have to tap debt markets at a time when bond yields are near unsustainable levels. Market players fretted that it may be forced to seek an international bailout.
Adding to the euro’s woes, Italian 10-year government bond yields topped 6 percent as sentiment on the indebted economy looked vulnerable to contagion from Spain’s worsening problems.
“The euro is in an extremely vulnerable position and downside risks are very strong indeed ... The Spanish banking crisis has the potential to knock the stuffing out of the euro zone irrespective of the Greek election results,” said Jane Foley, senior currency strategist at Rabobank.
“The issues for Spain are undoubtedly huge and most people are coming round to the idea that it will need to go outside of its borders for assistance. The longer it delays, the more the risk of a bank run.”
More falls could see the euro test a reported options barrier at $1.2400. Below there it has little chart support until $1.2151, a low hit in late June 2010, and then the 2010 low of $1.1876.
The common currency also lost more than 1 percent against the safe-haven yen, taking it to a four-month low of 98.274 yen. It recovered to trade at 98.425 yen, still down 0.9 percent on the day.
A government source told Reuters on Tuesday that Spain would likely recapitalize Bankia (BKIA.MC), which asked for 19 billion euros ($21 billion) on Friday, by issuing new debt and possibly drawing cash from the bank restructuring fund and Treasury reserves.
The euro’s weakness benefited the safe-haven dollar and yen, helping the dollar index, which measures its value against a basket of currencies, rise to a 20-month high of 82.749.
Technical analysts said a monthly close about the 100-month average in the dollar index around 81.82 may herald a shift in the longer-term trend of the dollar and reverse a multi-year drift lower.
The dollar also rose to a 15-month high against the Swiss franc at 0.9666 francs on EBS.
The higher-yielding Australian dollar fell 0.7 percent to $0.9777, slipping towards a six-month low at $0.9690, after weaker-than-expected retail sales data underscored the case for interest rate cuts.
Additional reporting by Jessica Mortimer; Editing by Andrew Roche