* Euro falls on doubts about Irish bailout, downgrade
* Traders continue to eye bond yields
* Euro to retest $1.30 as Spain remains a concern (Adds comment, updates prices, adds dollar move after Treasury auction)
By Wanfeng Zhou
NEW YORK, Dec 9 (Reuters) - The euro fell against the dollar on Thursday and looked set to retest the key $1.30 level after a ratings agency downgraded Ireland's sovereign debt and as investors waited for a vote on a rescue package for the debt-laden country.
The dollar dropped against the yen as Treasury yields fell after a solid 30-year bond sale, though analysts said the pair's higher trend stays intact on expectations yields will continue rising into the end of the year.
Ireland's Labor Party earlier said it would vote against a 85 billion euro rescue deal form the International Monetary Fund and the European Union when it comes before parliament next week, raising concerns about Ireland's ability to service and redeem outstanding debt. But two independent MPs said they would support the package, signaling its likely passage. For details, see [ID:nLDE6B81XS]
"The sovereign issues in the euro zone are continuing. There are a lot of headline risks for the euro coming out," said Amelia Bourdeau, senior currency strategist at UBS in Stamford, Connecticut.
Fitch became the first ratings agency to strip Ireland of its A credit status on Thursday, slashing it by three notches to BBB+, pointing to the fiscal costs of restructuring.
The euro last traded 0.2 percent lower at $1.3231 EUR=EBS, after hitting a session low of $1.3164 on trading platform EBS.
The next key target for the euro is $1.3150, followed by its 200-day moving average around $1.3115. Traders see the euro falling back to its December low of $1.2970 in coming weeks.
<^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^ Graphic on U.S. tax cuts, stimulus and deficits r.reuters.com/des29q Graphic on the yen and Japan/U.S. bond spreads: r.reuters.com/tyx39q Graphic on the euro and German/U.S. bond spreads: r.reuters.com/huz39q For story on tax deal impact on stocks see [ID:nN08175057] _^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^^>
Many analysts said that regardless of the outcome in Ireland, the euro is likely remain under pressure as market participants continue to focus on debt problems in other euro bloc countries, especially Spain, whose economy accounts for nearly 12 percent of euro-wide gross domestic product.
"Spain is a much, much bigger problem than Greece, Ireland and Portugal all put together," said Vasileios Gkionakis, macro strategist at Fulcrum Asset Management LLP in London. Fulcrum oversees about $900 million in assets.
"The banking sector is the pivotal issue as a lot of the government debt is owned by the country's baking sector. A potential government failure will imply a major hit onto bank balance sheets," he added.
DOLLAR AND YIELDS
A rise in U.S. Treasury yields over the last two sessions, which sent Treasury debt prices into their sharpest fall in nearly two years, has boosted the dollar against the yen on the view the proposed tax cut extension would spur growth.
Data showing a larger-than-expected decline in weekly claims for first-time U.S. jobless benefits added to the view.
"In the short term, the U.S. dollar will continue to be supported because the tax cut measures announced are pretty much a fiscal stimulus," said Gkionakis. "It may also imply that the Fed may act less decisively to try to push yields lower if the economy is doing better."
The dollar slipped 0.4 percent to 83.69 yen JPY=, after hitting a session low of 83.51 yen following the Treasury auction. For details, see [ID:nN09493895]
Analysts said investors were wary of taking on big positions as liquidity dries up toward year end, and this was why the dollar's rise had been limited compared with the jump in Treasury yields.
The dollar index has risen only 0.7 percent this week while the 10-year U.S. yield has soared around 25 basis points.
Daragh Maher, FX strategist at Credit Agricole, argued the correlation between currencies -- particularly the euro, yen and Australian dollar -- and movements in two-year yield differentials were stronger than for 10-year yields.
The two-year yield has risen less than 15 basis points this week, much less than the 10-year yield, as the short end of the yield curve has been anchored by expectations the Federal Reserve is unlikely to raise interest rates any time soon.
"For interest rates to gain greater traction on FX, the shorter end has to move, and we're not seeing that yet," Maher said.