NEW YORK (Reuters) - The euro fell to a four-month low against the dollar on Thursday on concerns about banks in Spain and Greece and the prospect of contagion if Greece exits the euro zone.
Growing aversion to risk drove investors towards the safety of the U.S. dollar, which rose to a four-month high against a basket of currencies. The euro also dropped to a three-month low versus the yen.
Talk of possible Spanish bank downgrades pushed European equities sharply lower and kept the euro under pressure.
Troubles in Greece and Spain added to concern the euro zone lacks a firm plan to deal with debt problems. That led to anxiety the crisis could eventually endanger the currency bloc itself.
"The true driver for the euro/dollar exchange rate is this increased uncertainty over the actual existence of the euro zone," said Anthony King Managing Director of investment grade fixed income at PineBridge Investments in London. PineBridge manages about $67 billion in assets. "In the near term, we don't see a reduction in those fears."
Shares in Spanish lender Bankia fell more than 20 percent following a report in the El Mundo newspaper its customers had pulled over 1 billion euros from accounts over the past week
This followed news on Wednesday the European Central Bank had stopped providing liquidity to some Greek banks because they had not been successfully recapitalized.
Investors were increasingly worried Greece could leave the euro following a second election to be held on June 17. Voters looked likely to opt for parties opposed to the terms of its international bailout.
The euro did get a bid after the release of an index of business conditions in the U.S. Mid-Atlantic region which came in well below expectations but the impact was fleeting and more on dollar weakness. [ID:nL1E8GH3KX].
The euro again swung back to losses after an IMF official said the European Central Bank had room for further easing, given a weakening economy, and for further unconventional policy measures.
The euro dropped to $1.2665, its lowest level since mid-January, past stop-loss sell orders below $1.2680 and on course for a test of its 2012 low of $1.2623, according to Reuters data. It last traded at $1.2701, down 0.1 percent.
"Euro/dollar is likely to have some support at the year-to-date lows around $1.26, but conceivably, it opens up back to the 2010 lows around $1.1875," said PineBridge's King. "That is certainly not impossible."
Higher yields for Spain at an otherwise well-received bond auction on Thursday reinforced concerns that its borrowing costs may become unsustainable as markets worry that the crisis could spread to other indebted euro zone countries.
Data on Thursday showed Spain's economy contracted by 0.3 percent in the first quarter, putting it firmly in recession after it shrank by the same pace in the fourth quarter.
The dollar index climbed to a four-month high of 81.682 as investors sought safety, while the euro also fell to 100.66 yen, its weakest since early February.
FED QE TALK
Some analysts said the dollar's gains could be capped after minutes of the Fed's April meeting revealed that policymakers thought the U.S. central bank might need to do more to support the economy if the recovery stumbles.
Some also said the euro may rebound as the market has already priced in much of the risk surrounding Greece. Most market commentators predict the euro's slide will continue.
"We wouldn't be surprised to see the euro/dollar going back to $1.30 and stay within the same range within three months - we are pretty much at the bottom of the range," said Pierre Lequeux, head of currency management at Aviva Investors in London.
"Perhaps it could drop to $1.25 if Greece is given the red card by Europe," he said. He added, however, that a Greek exit may be priced in already and pointed out that the euro has traded in a relatively narrow range since January.
Investors and speculators have built huge bearish positions against the euro since the start of the month after an inconclusive Greek election left the country on the road to bankruptcy and a possible chaotic exit from the euro zone.
Traders' skittishness toward the euro was visible in options markets, where one-month euro/dollar implied volatility traded close to the 2-1/2-month high hit on Wednesday at 11.30 percent.
The dollar fell as low as 79.26 yen, the lowest since mid February, before last trading at 79.37 yen, down 1.2 percent on the day.
