Euro rises after report on 2 trillion euro rescue fund

The euro rose on Tuesday after a British newspaper reported France and Germany have reached a deal to enlarge the euro zone bailout fund to two trillion euros in a bid to contain the region's debt crisis.

The rescue fund, known as European Financial Stabilization Facility (EFSF), is currently worth 440 billion euros.

The Guardian, citing senior European Union officials, said leaders of euro zone's two largest economies also agreed the region's banks should be recapitalized and private bondholders would take bigger haircut on their Greek debt holdings.

The Guardian article, together with gains in the stock market, swept away earlier disappointment over weak data on German investor sentiment, and a rating agency's warning on France losing its top credit rating.

"A report that France and Germany have agreed to a 2 trillion euro rescue fund and leveraging up the EFSF by five times is what's driving this stock and euro rally in the afternoon," said Brian Dolan, chief strategist at Forex.com in Bedminster, New Jersey.

The euro was last up 0.4 percent at $1.3792 after touching a session low of $1.36525 on trading platform EBS. The single currency climbed to a one-month high above $1.39 on Monday.

But the euro could resume its losses, analysts said, if stories re-emerge ahead of this weekend's European Union summit that leaders could not produce a convincing strategy to tackle the region's sovereign woes.

"That would be what the market's been looking for, and 2 trillion euros seems to be in the right neighborhood. But I have to take it with a grain of salt because (German Chancellor) Angela Merkel said earlier not to expect any big deal to come from the summit," Dolan said.

Earlier, Merkel said she expects European leaders would come up with a "work plan" for debt-laden Greece at the EU summit.

"People are second-guessing on a credible game plan on Sunday. We are in that mode still," said David Gilmore, partner at Foreign Exchange Analytics in Essex, Connecticut.

Germany has been reluctant to back aggressive measures to contain the crisis due to worries that it has already overextended itself as its economy is slowing.

On Tuesday, a survey showed German investor sentiment fell to the lowest in nearly three years.

Disappointing quarterly results from International Business Machines Corp and a rare loss from Goldman Sachs also weighed on risk appetite and hurt the euro, although U.S. stocks rebounded and were higher in mid-afternoon trade.

U.S. blue chip stocks were up around 2 percent while the MSCI world equity index was last up 0.6 percent.

French Rating

Moody's warned on Monday it may slap a negative outlook on France's Aaa credit rating in the next three months if the costs for helping to bail out banks and other euro zone members stretch its budget too much.

The premium investors demand to hold French government bonds rather than benchmark German Bunds rose further to hit a 19-year high after the Moody's warning. The cost of insuring French debt against default rose to near record highs.

Lee Hardman, currency economist at Bank of Tokyo-Mitsubishi UFJ in London, said the warning reinforced concerns that the leveraging up of the European Financial Stability Facility and government recapitalization of European banks may further erode investor confidence in core euro zone sovereign debt.

"Should France lose its AAA rating it would likely result in reducing the EFSF's lending capacity or require lending to be backed by higher guarantees."

Analysts said the outcome of a November summit of Group of 20 leaders in Cannes, France is key to regaining investors' trust.

"If there's no action taken on plans for bank recapitalization at the G20 then the euro will be sub $1.30 very quickly," said Geoff Kendrick, currency strategist at Nomura in London.

[Source: By Richard Leong, Reuters, New York, 18Oct11]

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