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 Harsher steps could be a particular hit to euro zone powerhouse
Germany given its strong trade links with Russia.
The European Union on Tuesday threatened Russia with additional
penalties over Ukraine following the downing of a Malaysian airliner
last week. Foreign ministers for the first time raised the
possibility of restricting Russia's access to European capital
markets.
The euro touched $1.3455, its lowest since November 2013 and
investors expected more losses in coming days. The single currency
was flat at 136.60 yen, having hit a 5-1/2-month low hit earlier in
the day.
"There is quite broad-based pressure building on the euro and there
are a number of factors driving that. Europe is directly exposed to
Russia by trade – Germany in particular – so sanctions could
potentially have a negative impact on the euro," said Ian Stannard,
a currency strategist at Morgan Stanley.
The euro hit a near two-year low against the British pound of 78.69
pence before recovering to 79.07 pence, up 0.2 percent on the day,
after Bank of England minutes failed to boost expectations of an
interest rate hike by year-end.
In fixed income markets, German government yields fell close
to record lows on concern over the potential harm more sanctions on
the EU's third-biggest trading partner could cause to the euro zone.
European stocks rose as forecast-beating earning offset sanctions
worries. However, the Euro index of euro zone blue-chips is
down 0.8 percent since the end of June, compared with a 1.3 percent
rise in the U.S. S&P 500.
Morgan Stanley's Stannard said comments overnight from Chinese
officials, suggesting there have been capital outflows from China,
would imply that Beijing's reserve accumulation is slowing, reducing
the need for the purchase of alternative reserve currencies of which
the euro has been a beneficiary.
Traders said it was significant that the euro had closed below $1.35
on Tuesday for the first time this year, making the currency appear
technically weak. It could fall below reported option barriers at
$1.34 in the coming days if flash PMI and German IFO data
disappoint, they said.
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DOLLAR STRENGTH
The dollar index, which tracks the greenback against a basket of six
major rivals, was steady on the day at 80.747, not far from a
Tuesday high of 80.837 touched on expectations that higher U.S.
interest rates are on the horizon.
Data on Tuesday showed U.S. inflation was 0.3 percent in June, in
line with forecasts, though core inflation, excluding food and
energy prices, undershot expectations.
However, markets still expect the U.S. Federal Reserve to continue
tapering its bond purchase program and then raise interest rates in
the latter half of 2015, in contrast with the European Central Bank
which cut rates last month and has kept the door open to a
large-scale asset purchase program.
"Euro/dollar downside movement is mainly driven by the divergence in
the economic growth of the two areas and the consequent different
monetary policies," said Francesco Scotto, a portfolio manager at
RTFX Fund Management.
"With the business confidence in Germany pointing south and the
IMF's warning on the weak economic recovery in the euro zone, we
should not be surprised by this movement."
The Australian dollar rose over half a percent to $0.9448 after
higher-than-expected data on June underlying inflation dented
expectations of future rate cuts.
(Editing by Nigel Stephenson)
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