The euro neared a one-year low against the U.S. dollar on Wednesday after data showed euro zone banks were still hoarding cash rather than lending it out, unnerving markets ahead of an important Italian bond sale.
Year-end conditions kept volumes light, but traders said investors who were engaged this week were spooked by European Central Bank data showing euro zone banks deposited a record €452-billion ($585.18-billion U.S.) with the central bank.
That came just days after the ECB provided banks almost half a trillion euros worth of three-year loans at cut-rate prices to encourage lending and ease strains on the banking system caused by a two-year old sovereign debt crisis.
"If European banks are still this concerned, it's not a good sign," said Karl Schamotta, senior markets strategist with Western Union Business Solutions.
Banks typically park only excess cash in the ECB's low-interest rate deposit accounts, often at a loss. That they were doing so after accessing cheap ECB loans was troubling, Mr. Schamotta said.
"That underlines the possibility that this liquidity crunch is getting worse and will continue into the new year," he said.
The euro fell as low as $1.2910, its lowest since Jan. 10, before clawing back to $1.2933, about 1 per cent below its level late Tuesday in New York. The slide below $1.30 triggered automatic sell orders that sped up the slide, traders said.
Unease about the euro zone lifted the safe-haven appeal of U.S. assets. The dollar rose 0.2 per cent to 77.99 yen and 0.9 per cent to 0.9424 Swiss francs, while sterling shed 1.2 per cent to $1.5477.
Optimism seen after Italy halved the price it pays for six-month loans faded after the ECB report and as traders looked ahead to Thursday's more challenging auction of three- and 10-year government debt.
Investors have been shunning longer-maturity Italian government bonds over the last few months for fear slow growth and a tough package of spending cuts and tax hikes will make it difficult for the country to finance its large public debt burden.
Italy must attract strong demand on Thursday from global investors to hold benchmark 10-year borrowing costs below the 7 per cent level that markets fear is not sustainable.
Even then, traders said one or two decent auctions will not solve a two-year-old debt crisis that has already forced Greece, Ireland and Portugal to seek emergency rescues.
"You can't make your decision based on one auction," said Ihab Salib, senior portfolio manager and head of international fixed-income at Federated Investors in Pittsburgh. "It's going to be an evolution of more than one event."
Traders emphasized that year-end liquidity was thin, exaggerating moves, but most said there was little reason to get long the euro before the year ends.
"It might pop up to $1.32 because of year-end squaring, but I haven't really seen it. There's no reason to own the euro going into the new year," said John Doyle, a currency strategist at Tempus Consulting in Washington.
While the euro is off about 3.2 per cent against the U.S. dollar this year, the currency has swung widely as investors fret the 17-nation monetary union could face drastic changes because of the debt crisis.
That volatility could continue into next year, Mr. Salib cautioned.
"Unless you're really doing your homework and you're capable of being fairly active, you're better off just staying away," he said. "Moves that used to take weeks and months to develop can happen in a two- or three-day period."