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Wednesday December 1, 2010 - 12:39:28 GMT
Reuters - www.reuters.com

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FOREX NEWS - Euro gets respite as yield spreads tighten

6:36am EST

* Euro rises, broad selling momentum cools for now

* Yield spreads for Portugal, Spain vs Germany tighten

* Focus on ECB meet, liquidity ops, possible bond buys (Adds comment, updates throughout)

By Naomi Tajitsu

LONDON, Dec 1 (Reuters) - The euro rose on Wednesday as a three-day selling spree lost steam, but doubts about whether the euro zone can contain debt problems facing some states kept the single currency in range of a 2 1/2-month low versus the dollar.

A slight narrowing of yield premiums of government debt in Portugal, Spain and Italy over safe-haven German bonds also supported the euro, but market participants said the single currency remained vulnerable to more selling. [nLDE6B00EP]

Investors awaited a European Central Bank policy meeting on Thursday. Some expect the central bank to keep its three-month liquidity operations unlimited to help banks struggling for cash, which analysts said was also supporting the euro.

ECB President Jean-Claude Trichet on Tuesday suggested the central bank may expand purchases of government bonds to help drive down rocketing yields. [ID:nLDE6AT26U]

"The market's been caught short on euros. Periphery yield spreads have tightened somewhat, and the market's pricing in the possibility that the ECB won't be too aggressive tomorrow," said Geoffrey Yu, currency strategist at UBS.

"The euro's come down quite quickly from $1.40, so some people just want to take a breather."

Investors largely brushed off a relatively smooth auction of 12-month Portuguese Treasury bills even as Lisbon was required to pay a premium on its borrowing as its fiscal problems mount.

Still, many believe investors are still speculating that other countries may follow Ireland and Greece in asking for bailouts, and any suggestions of this would drag the euro lower.

Portugal is widely seen as being next in line for a bailout. Ratings agency S&P on Tuesday put its A-minus rating on review for possible downgrade. [ID:nN30292510]

<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^

Euro zone debt timeline: link.reuters.com/nyx95q

Take a Look on euro debt crisis: [ID:nLDE68T0MG]

Euro zone crisis coverage r.reuters.com/hus75h

Graphic on debt crunch: r.reuters.com/zem66q

^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>

By 1114 GMT, the euro EUR= had climbed 1 percent to the day's high of $1.3111, pulling away from a 2 1/2-month low of $1.2969 hit on Tuesday.

Some traders said the euro was supported around $1.2950, which was seen to be the bottom of a selling target. Others suspected options at that level were due to expire on Friday.

Still, many in the market believe euro trading will become more volatile in the near term, with one-month implied volatility in the currency EUR1MO= climbing to roughly 16 percent early on Wednesday, its highest since June.

DOLLAR SLIDES

The euro's rise lifted other currencies also considered to be higher risk, including the Australian dollar. The Aussie rose 0.6 percent to $0.9630 AUD=D4, recouping earlier losses versus the U.S. currency suffered on weak economic growth data.

The safe-haven Swiss franc CHF= fell to 1.0066 francs per dollar, its weakest since late September.

Against the yen, the dollar was flat on the day at 83.70 JPY=.

The greenback slipped 0.5 percent versus a currency basket .DXY to 80.795, but stayed near a 2 1/2-month high hit on Tuesday as the currency, the most liquid and therefore considered safe, has benefited from the euro's problems.

Euro zone debt problems are also raising the cost of accessing dollar cash for companies and banks.

While dollar interest rates such as three-month LIBOR USD3MFSR= have risen only slightly in the past few days, euro/dollar basis swap spreads have risen sharply in recent weeks EURCBS in a possible sign that some euro zone banks are trying to raise dollar cash through swaps.

Analysts said any move by the ECB to loosen its policy stance or extend bond buying on Thursday may help to stabilise market sentiment.

"The rhetoric and action by the ECB will become more actively targeted at securing some stability in the sovereign bond market. This ... should help support the euro or at least re-introduce some two-way risk," analysts at Credit Agricole said in a note.

(Additional reporting by Tokyo Treasury team; Editing by John Stonestreet)

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