By Yoshiaki Nohara and Ron Harui May 12 (Bloomberg) -- The euro weakened for a second day against the dollar and the yen on concern the region’s most- indebted nations will struggle to contain their deficits, slowing Europe’s economic recovery. The yen rose versus all of its 16 major counterparts after the Wall Street Journal reported Morgan Stanley is being investigated by federal prosecutors over allegations it misled investors, boosting demand for the safety of Japan’s currency. The pound fell for the first time in three days on speculation the new U.K. coalition government will struggle to agree on policies to cut its budget deficit. “Each nation in the euro zone still has to work on rebuilding its finances,” said Nobuaki Kubo, vice president of foreign exchange in Tokyo at BBH Investment Services Inc., a unit of New York-based Brown Brothers Harriman & Co. “Optimism about the loan package didn’t last long as investors stopped pushing up the euro. People remain skeptical about the euro’s outlook in the medium and long term.” The euro declined to $1.2636 as of 7:52 a.m. in London from $1.2662 in New York yesterday. The currency slumped to $1.2529 on May 6, the weakest level since March 5, 2009. The yen rose to 117.16 per euro from 117.32. Japan’s currency traded at 92.72 per dollar from 92.65. Europe’s currency has retreated since climbing to as high as $1.3094 on May 10 when euro zone leaders announced an agreement to provide loans of as much as 750 billion euros ($947 billion), including support from the International Monetary Fund. Greece’s budget deficit of 13.6 percent of gross domestic product is the second-highest in the euro zone after Ireland’s 14.3 percent. As part of the bailout plan, Spain and Portugal also pledged deeper deficit reductions than previously planned. ‘Find Faults’ “As markets began to find faults with the loan package, it’s become clear that this will not solve the roots of the crisis,” said Tsutomu Soma, a bond and currency dealer at Okasan Securities Co. in Tokyo. “Investors are finding fewer reasons to buy the euro.” U.S. President Barack Obama and Spain’s Prime Minister Jose Luis Rodriguez Zapatero yesterday talked about the need for Spain to take “resolute action” to reduce its deficit. The euro has lost 8.1 percent this year, according to Bloomberg Correlation-Weighted Indexes. The dollar has gained 5.6 percent, and the yen has advanced 6.1 percent. Yen Gains Japan’s currency rose for a second day versus the euro after the WSJ reported, citing people familiar with the matter, that Morgan Stanley misled investors about mortgage derivatives it helped put together and sometimes bet against. “The news on Morgan Stanley may stoke concern about stricter financial regulations,” said Masato Mori, a senior manager at NTT SmartTrade Inc., a unit of Nippon Telegraph & Telephone Corp. “Risk aversion is causing the yen and dollar to be bought.” Morgan Stanley said it hadn’t been contacted over the matter and the investigation is at a preliminary stage, the newspaper reported. The pound retreated from near a 10-month high versus the euro on speculation Conservative leader David Cameron and Liberal Democrat leader Nick Clegg will fail to fulfill pledges made to cut government debt that Standard & Poor’s says will rise to 77 percent of gross domestic product this year. The U.K. currency strengthened yesterday when Cameron replaced Gordon Brown following an unprecedented five days of talks after the May 6 elections failed to provide a majority for any single party. ‘Underlying Differences’ “There are real underlying differences” between the coalition parties, said Adrian Foster, head of financial-markets research for Asia at Rabobank Groep NV in Hong Kong. “How are they going to agree on a set of policies when they both have quite different opinions on different things? It’s unlikely there’ll be any positive drivers from the U.K. political scene for the pound for the next couple of weeks at least.” The leaders of the coalition government will propose 6 billion pounds ($8.94 billion) of cuts within 50 days to reduce the budget deficit, raise the threshold to pay income tax, study a split between retail and investment banking and increase the Bank of England’s oversight of the financial industry, Conservative officials said. The pound fell 0.2 percent to $1.4924, and declined 0.1 percent to 84.74 pence per euro. To contact the reporters on this story: Yoshiaki Nohara in Tokyo at ynohara1@bloomberg.net; Ron Harui in Singapore at rharui@bloomberg.net.

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