Euro recovers from lows, French and Spanish auctions key

 
LONDON, Nov 17 (Reuters):

* Euro recovers from lows, but prospects remain grim
* France and Spanish auction to provide direction
* Fitch warning on U.S. banks sours risk sentiment

The euro recovered from five-week lows against the dollar and the yen on Thursday as investors chose to book some profit and take stock of Europe's debt crisis ahead of bond sales by Spain and France.

The auctions come at a critical time, with the crisis threatening to ensnare core economies like France, the Netherlands and Finland, boding ill for the euro.

Still, with most investors already running bearish positions on the euro over the past few months, the room to bet even more heavily on a drop in the common currency is limited.

The euro was up 0.2 percent at $1.3495, recovering from a five-week low of $1.3421, with offers cited at $1.3510-15 while decent demand is seen at $1.3455-60. There is also talk of an option barrier at $1.34, all of which leaves the euro hemmed within its recent range.

"There is a bit of short covering in the euro which is lifting it and which is not surprising given the stretched bearish euro positions," said Chris Walker, strategist at UBS.

"The focus is on the French and Spanish auctions and a good result will see the euro benefit."

Spain will aim to sell between 3-4 billion euros of a new benchmark bond while France, the region's second-largest economy, is looking to sell 6-7 billion euros of debt.

Bond markets have driven Spanish yields more than 100 basis points higher so far this month, despite ECB moves to cap the rise, while French/German 10-year yield spreads have also hit their highest in the euro era.

Both Spanish and French bonds were again under pressure ahead of the auctions on Thursday.

Any boost in the euro from a decent auction is likely to prove fleeting and will give investors a fresh opportunity to build fresh bearish positions.

"There are signs of more widespread contagion in the eurozone outside of Italy and Spain with spreads widening this week in Austria, France and Belgium," said Chris Gothard, head of FX for Brown Brothers Harriman in Hong Kong.

"We think there are further downside risks from here with a convincing downside break of $1.3400 opening up the door to test the recent lows near $1.3150," he said, adding that his bank's forecast is for the euro to drop to $1.29 by year-end.

The outlook for euro zone assets has taken a beating in the past few hours after Moody's downgraded 12 of the German public sector banks, while Fitch has given a warning of contagion risks from the problems in Europe to the rest of the world.

Against the yen, the euro touched a five-week low of 103.40 yen at one point, and was last at 103.60 yen , down 0.1 percent on the day.

SAFETY SOUGHT

In a blow to risk appetite, Fitch warned it may downgrade its "stable" outlook for U.S. banks, because of contagion from problems in troubled European markets.

According to Bank for International Settlements (BIS) data, US banks' foreign claims on Europe totalled around $1.44 trillion at the end the second quarter of 2011, with exposure to peripheral economies like Portugal, Ireland, Italy, Greece and Spain totalling a $188.8 billion.

The bulk of their European exposure is to the UK, Germany and France, highlighting the concerns about the global banking sector if the debt contagion spreads beyond the peripheral economies.

All of which means that currency investors will focus on the strong link between developments in the euro-zone sovereign debt market and the European banking sector.

Increased preference towards safe-havens like the greenback saw the dollar index trade 0.25 percent higher on the day at 78.22. It rose to a one-month high against the Swiss franc, advancing to 0.92370 francs on trading platform EBS, with speculation that the Swiss National Bank would intervene in the currency market weighing on the franc.

But the dollar underperformed the yen, and was down 0.14 percent at 76.94 yen.

The high-yielding Australian dollar hit a five-week low of $1.0021 at one point, and was last flat on the day at $1.0073.