The euro held above a four-month low on Tuesday after German economic growth beat expectations, although gains could prove fleeting as the political stalemate in Greece stoked concerns Athens may renege on bailout pledges and exit the currency bloc. Germany, the euro zone's largest economy, grew 0.5 percent in the first quarter of 2012, dispelling fears of a recession.
But a survey of German analyst and investor sentiment fell sharply in May, while GDP in France flatlined and Italy's economy contracted by 0.8 percent. Concerns about Greek political instability and slowing Chinese and global growth were expected to keep demand for the euro and other perceived riskier currencies in check and support demand for the safe-haven dollar and yen. The euro was last up 0.25 percent at $1.2856, with traders citing buying by macro funds, recovering from a four-month low of $1.2814 hit during the Asian trading session.
"We have had several down days in the euro and this is just an adjustment in the market. German economic strength won't help the euro zone, we need to see a solution in Greece and more robust growth in the periphery," said Steven Saywell, head of European FX strategy at BNP Paribas. Signs of stagnation in wider euro zone growth were likely to keep pressure on the European Central Bank to support the economy by loosening monetary policy.
"Our view is that the euro will continue to grind lower. A lot of this is to do with the euro's yield advantage being undermined. Weaker data means the market is continuing to price in easing from the ECB," Saywell said. The euro found some support at $1.2827, the 76.4 percent retracement of its 2012 rally from $1.2624 to $1.3486.
A clear break of that retracement level could open the way for a test of the January low of $1.2624, though some analysts said the euro could enjoy some rebound in the short term, having fallen more than 3 percent so far this month. Any bounce in the euro could run out of steam around reported sovereign offers at $1.2880-$1.2900. Peripheral bond yields were still at elevated levels highlighting the risk of contagion from Greece spreading throughout the euro zone.
Data on Tuesday showed the Greek economy deep in recession, and there was little hope of a government being formed soon. Greek President Karolos Papoulias's proposal to put together an administration of technocrats was unlikely to be accepted, making a new election the most likely outcome. The German ZEW think-tank said uncertainty after the recent elections in Greece and France had probably contributed to a sharp slide in sentiment. The index plunged to 10.8 in May from 23.4 in April, below a consensus forecast of 19.
These economic numbers change nothing for the euro zone," said Stuart Frost, head of Absolute Returns and Currency at fund manager RWC Capital. "Germany is the standout, based on the GDP numbers, but the rest are struggling and we expect the euro to drift lower towards those lows of $1.2630." Against the yen, the dollar was steady at 79.90 yen, above a 2-1/2-month low of 79.428 yen hit last week, with major support seen at 79.14, a 61.8 percent retracement of its rally from February to March. The Australian dollar touched a five-month low of $0.9945 after minutes of the latest Reserve Bank of Australia meeting showed concerns about a cooling in growth and inflation were behind its unexpected 50 basis point rate cut in May. It pared losses to trade at $0.9993, up 0.3 percent.
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