The euro rallied from a four-month low against the dollar on Friday as investors pared bets against the single currency after a more than 3 percent drop this month, but concerns about Greece and Spain were likely to keep it under pressure. Positioning ahead of the weekend meeting of the Group of 8 major industrialised nations and technical support also helped, traders said, as the euro approached its January low of $1.2623.
Gains accelerated after a wave of stops were triggered in the euro's grind higher. Despite Friday's rebound, investors preferred the relative safety of the US dollar and the Japanese yen as worries about Europe persisted after Moody's cut the credit ratings of 16 Spanish banks late on Thursday.
--- Worries on Europe drive support for dollar, yen Some traders said investors were wary of placing bets ahead of the meeting of the G8, even though expectations were low that any significant actions would be taken to address the euro zone debt crisis. Extreme short positioning in the euro, which hit a record high in the week ended May 15, may have also prompted a squeeze in short bets.
Although no economic policy decisions are expected from the G8, officials said US President Barack Obama hoped to promote discussion on steps to resolve the euro zone crisis. "Even as position squaring dominates ahead of this weekend's summit of G8 leaders, strong undercurrents of risk aversion persist, as a result of which the US dollar remains net bought on balance," said Samarjit Shankar, managing director of global FX strategy at BNY Mellon in Boston.
The euro tumbled to $1.2640, not far from its trough of 2012, before recovering to trade 0.5 percent higher at $1.2763. It hit a session peak of $1.2794 after stops were triggered around $1.2750. The euro was still on track for its third straight week of losses, based on Reuters data. The 14-day exponential relative strength index posted at 15.526, leaving the euro in oversold territory since May 7.
The euro fell to 100.17 yen, its lowest since early February, before reversing course to trade at 100.97, up 0.3 percent on the day. Strong demand for the greenback helped drive the dollar index to a four-month high early in the global session, but those gains evaporated.
Currency speculators increased bets in favour of the US dollar to the highest level since at least mid-2008, according to data from the Commodity Futures Trading Commission released on Friday. The value of the dollar's net long position rose to $28.52 billion in the week ended May 15, from $20.95 billion the previous week. "Although the US dollar remains overbought, the headline-driven market continues to increase the appeal of the greenback as the turmoil in Europe intensifies," said David Song, currency analyst at DailyFX.
France's new president, Francois Hollande, said on Friday Spain's banks should be recapitalized by Europe's bailout funds and everything must be done to keep Greece in the euro zone. "If it's not Greece, it's Spain that we talk about to sell the euro. People are looking for bad news and they are concerned there appears to be no solution," said Lutz Karpowitz, currency analyst at Commerzbank in London.
Greece faces fresh elections on June 17, with many investors increasingly concerned a victory for anti-bailout parties could lead to Greece exiting the euro zone. A recent poll showed Greece's conservatives have overtaken the anti-bailout leftist SYRIZA in popularity, although the volatile political mood meant most analysts saw the outcome of the elections as a significant risk.
Worries about Spain's banks and prospects of more state bailouts for lenders kept the country's borrowing costs high. Talk of a ban on naked short-selling of Spanish banking stocks lifted Europe's bank shares. This brought some relief for the euro, but the common currency's medium-term prospects remained bearish.
Reflecting that, one-month euro/dollar implied volatility climbed to around 11.55 percent while three-month risk reversals - a measure of relative demand for bets on the euro rising or falling - were at -3.5 vols on trading platform GFI in favour of more euro weakness. The dollar was down 0.4 percent against the yen at 79.02 yen after hitting a three-month low of 78.99, according to Reuters data. Traders cited stop-loss orders below 79.00 yen and 78.80 yen, while offers were likely to cap dollar gains around 79.50.