LONDON, Aug 21 (Reuters) - The yen strengthened broadly and high-yielding currencies weakened on Tuesday as continued nervousness in financial markets prompted wary investors to shun carry trades.
European stock markets struggled to make headway, government bonds rose and spreads of emerging market debt over benchmark Treasury yields widened, all reflecting investors' caution on the current state of global markets.
The chief executive of German state-backed bank WestLB said on Tuesday the country's banking sector was in a "not uncritical situation" and the Bank of England said it had lent money to an unidentified borrower or borrowers on Monday via its standing facility.
This is the first time it has lent via this facility, which is fixed at 100 basis points above the base rate, in over a month. While not in itself a major surprise, the news did little to soothe worries that the credit distress swirling through markets shows no sign of dissipating.
"Our risk indicator, which measures risk appetite from a more macro level, confirms that a major shift in medium-term market sentiment is taking place, suggesting that the impact from the current credit crisis is likely to be more significant and prolonged than the market was initially assuming," said Ian Stannard, senior currency strategist at BNP Paribas in London.
"Equity markets hold the key, especially in the short term. A renewed selloff in equities will put the carry trade back under pressure."
At 1000 GMT the dollar was down 0.7 percent against the yen at 114.14 yen <JPY=>, and the euro was also 0.7 percent lower at 153.75 yen <EURJPY=>.
The New Zealand dollar was down 1 percent against the yen at 79.23 yen <NZDJPY=> and sterling was down 1.2 percent at 225.71 <GBPJPY=R>.
EYES ON PAULSON, BERNANKE
The Australian dollar was down 1 percent against the greenback at $0.7985 <AUD=>, while sterling was down 0.5 percent at $1.9775 <GBP=>.
The dollar was steady versus the euro at $1.3471 <EUR=>.
The euro held steady after the European Central Bank held its weekly tender, allotting 275 billion euros in 7-day refinancing to the region's banks. See [nL21832470].
Investors are now turning their attention to a meeting between Fed Chairman Ben Bernanke, Treasury Secretary Henry Paulson and Senate Banking Committee Chairman Chris Dodd later on Tuesday at which they will discuss conditions in financial markets.
The closed-door meeting is to take place at 1400 GMT and Dodd is expected to hold a news conference afterwards.
Last Friday the Fed cut the discount rate it charges on direct loans to banks by half a percentage point to 5.75 percent, saying credit market tightening could slow U.S. growth.
That fuelled expectations that the U.S. central bank could lower the federal funds rate from the current 5.25 percent, given the threat to the economy from evaporating credit.
"Volatility prevails across financial markets as the euphoria which met Friday's actions by the Fed gives way to a more realistic assessment of the state of play," wrote Neil Mellor, currency strategist at Bank of New York-Mellon in a note to clients on Tuesday.
The market will also look to comments by Richmond Fed President Jeffrey Lacker in a speech on the economic outlook at 1630 GMT.
Currencies paid scant attention to data that showed Germany's ZEW investor sentiment index falling much more than expected in August, or June trade data for the euro zone. See [nBAE000830] and [nL2158887].
Reuters journalists are subject to the Reuters Editorial Handbook which requires fair presentation and disclosure of relevant interests.
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