03/27/2013 08:07 am ET Updated Mar 27, 2013

Euro Nears 4-Month Low As Cyprus Ignites Financial Stability Fears

* Euro still smarting from 'Cyprus model' suspicions

* Little sign of contagion to Italy, Spain

* Yen under pressure ahead of April 3-4 BOJ meeting

TOKYO, March 27 (Reuters) - The euro stayed near a four-month low against the dollar on Wednesday as fears about the currency bloc's financial stability festered in the wake of the Cyprus rescue deal, while the yen dropped on stronger hopes for bond buying by the Bank of Japan.

The euro dropped 0.1 percent to $1.2849, not far from the four-month low of $1.2828 hit on Tuesday.

The common currency is still suffering from suspicions that bank depositors and bond holders may be forced to foot the bill in future rescue deals in the euro zone, with the Cyprus bailout used as a precedent.

Jeroen Dijsselbloem, head of the Eurogroup of finance ministers, ignited those suspicions on Monday when he said the rescue plan for Cyprus would serve as a model for future euro-zone banking crises on Monday. He later appeared to backtrack, saying Cyprus was a unique case, but the damage was done.

"Systemic risk remains for the euro, no matter what," said Michiyoshi Kato, senior vice president of forex sales at Mizuho Corporate Bank in Tokyo.

Some analysts said alarm bells could ring if the two-year German bond yield goes negative. It is currently at 0.005 after sliding steadily from a 9-month high of 0.29 hit in late January.

"The euro would likely come under further heavy selling pressure if the yield was to drop below zero, as it didn't even do that in the aftermath of the Greek election last year," said Minori Uchida, senior analyst at Bank of Tokyo-Mitsubishi UFJ.

The yield on two-year German bonds last dipped into negative territory in December, after doing so for the first time ever in July as Spanish and Italian borrowing costs hit crisis levels.

"But if it stays positive, there will be little other downward pressure on the euro for the moment," Uchida said.

Some analysts said the single currency could steady in time for the Easter holidays, as there is little sign of dreaded contagion in the euro zone's larger economies, such as Spain and Italy, with debt yields remaining within recent ranges.

The euro edged up 0.2 percent against the yen to 121.71 on Wednesday, as the Japanese currency fell on reinforced expectations of major stimulus from the BOJ after the Nikkei business daily said the central bank will boost bond buying at its policy review meeting on April 3-4.

Yen bears were further cheered after sources told Reuters the BOJ would likely start open-ended asset purchases immediately rather than in 2014, as originally agreed in January, and also buy longer-dated bonds.

The news nudged the dollar up 0.3 percent to 94.72 yen, extending its rebound from a one-week low of 93.53 yen on Monday.

"Some hedge funds were positioning for the dollar to drop all the way to 90 yen after it broke below 94," said Kato of Mizuho Corporate Bank. "But as it quickly rebounded, the range could have been hiked upwards. People are searching for the next target- though at the end of the fiscal year, no one wants to move much."

The Aussie lost 0.1 percent to $1.047, with the Reserve Bank of Australia's reassurance that the country's banks are robust and prepared to meet new strict liquidity controls further dimming prospects of a rate cut.

Helped by a stellar jobs report on March 14, the Aussie had rallied 3.8 percent from a 7-1/2 month low on March 4 to a high of $1.0497 on Tuesday.

While the currency added 4.5 percent in the same period against the broadly weakening yen, analysts said it will take equally strong data in April to push the Aussie over tough resistance at 100 yen. On Wednesday, it gained 0.2 percent to trade at 99.23 yen.

The euro struggled against the resurgent Australian dollar, limping up 0.1 percent to A$1.2268, still close to a four-month low of A$1.2225 hit on Tuesday.



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