The euro hovered near a three-month low versus the dollar this morning as a plan to tax Cyprus savings accounts to help fund a bank bailout fuelled fears about the stability of euro zone financial institutions.
While Asian investors were relieved to see limited fallout from the Cyprus deal on other euro zone countries so far as the rise in Spanish and Italian debt yields appeared to be contained, analysts were guarded about the near term.
"Looking at European and U.S. markets yesterday, the injury seems to be shallow. But it would be premature to say it will heal in just two days," said Sumitomo Mitsui Bank chief strategist Daisuke Uno.
The euro traded at $1.294, slightly higher than late US levels, but still close to a three-month low of $1.288 hit yesterday, with its 200-day moving average of $1.287 today a strong support.
It recouped some of its losses in late US yesterday trade after euro zone ministers urged Cyprus to let smaller savers escape the proposed levy on bank deposits.
Against sterling, the euro edged up from a five-week low of 85.34 pence hit on Monday to change hands at 85.78 on Tuesday.
The common currency now faces an uphill battle to recover to Friday's close of $1.307 as it remains unclear whether the Cypriot parliament will endorse the plan needed to secure financial rescue at a parliamentary debate scheduled for this afternoon.
As Nicosia extends its bank holiday until Thursday to avert panic, market players pondered whether savers in larger European countries would get nervous and withdraw funds, although there was no immediate sign of that yesterday.
Analysts at Barclays say they see limited risk of contagion to other countries. "We consider that the scope of potential contagion to other peripheral countries in terms of deposit outflows and sovereign debt is considerably more limited than if such a decision would have been taken in previous programmes. Specifically, we consider the likelihood of a bank run in other periphery countries to be limited, including in Greece, " they wrote.
The radical move on deposits had limited impact on Spanish and Italian debt on Monday. Their yield rose but stayed well within their recent ranges.
Commodity currencies, which took a hit in tandem with the euro initially, have recouped most of losses, with Australian dollar trading at $1.037, not far from five-week high of $1.041 hit last week.
