Euro hits 17-month low, dollar near pre-Liberation Day highs

By Stefano Rebaudo

Oct 5 (Reuters) - The euro slid to a 17-month low against the dollar on Monday as concerns about France's ability to rein in its budget deficit and a sharp bond market selloff last week stirred fears of a return of sovereign debt crisis dynamics in the euro zone.

French government bonds have come under pressure as expectations of higher policy rates and rising political uncertainty ahead of the 2027 election cast doubt on the ability of the euro area's second-largest economy to put its public finances on a more sustainable footing.

The yield gap between French bonds and safe-haven Bunds – a market gauge of the risk premium that investors demand to hold French debt – widened to about 150 basis points on Friday, the highest since the euro zone's sovereign debt crisis in 2011, before pulling back to 140 bps. It was last up 5 bps to 145.50.

“Latest bond market dynamics are increasingly concerning and somewhat reminiscent of a sovereign debt crisis. Friday's acceleration of the selloff in OAT spreads and flight-to-quality patterns in Bunds are a case in point,” said Hauke Siemssen, strategist at Commerzbank.

“The (French) spread selloff seems to increasingly feed on itself, creating a dangerous market backdrop,” he said, adding that there is a fundamental justification for wider OAT spreads.

The euro sank to as low as $1.1161 in Asian hours, its weakest since May 2025, and was last down 0.47% at $1.12. The single currency recorded on Friday its fourth straight weekly fall against the dollar, its steepest in around four months.

Analysts argued that France's fiscal problems were daunting enough on their own, but an upcoming presidential election and a hung parliament where compromise has often proved impossible make them even harder to address.

Planned budget cuts, which have deepened an already acute funding crunch in the education sector, have fuelled discontent and sparked protests across the country.

The single currency dropped 1.8% against the Swiss franc since last Thursday and was last down 0.32% to 0.9295.

"Euro/Swiss franc is historically the cleanest way to hedge the euro zone fiscal risk, and we could see further downside," said Francesco Pesole, forex strategist at ING.

"Still, the franc’s idiosyncratic fragilities may get in the way," he added, referring to the low levels of interest rates and the central bank's willingness to act against a rapid appreciation of the franc.

US DOLLAR CLOSE TO LIBERATION DAY'S HIGHS

The euro's appeal as the market's primary alternative to the greenback was already fading after the Federal Reserve's September rate hike, but last week's sharp widening in French bond spreads dealt a further blow, analysts said.

Traders are now pricing in an 80% chance of the US central bank holding rates steady in October, compared with 36% a week earlier, the CME FedWatch tool showed. They still expect a hike in December and another two in the first half of 2027.

The US dollar index , which measures its value against a basket of six major currencies, rose 0.30% to 102.23, after reaching 102.53, its highest level since April 10, 2025.

'Liberation Day' is the name given by President Donald Trump to the sweeping tariff package he unveiled in early April 2025, which triggered a broad selloff in US assets. The dollar index was around 104 before the announcement.

YEN SUPPORTED BY TIGHTER POLICY

The Japanese currency was roughly unchanged at 157.92 , supported by recent verbal warnings from the government and authorities against yen depreciation and its safe-haven status.

Concerns about Japan's fiscal outlook eased as Prime Minister Sanae Takaichi reiterated her commitment to fiscal sustainability, reassuring investors worried about rising bond yields and deteriorating public finances.

Data showed on Friday that annual core inflation in Japan's capital accelerated in September at its fastest pace in 10 months, bolstering the case for further interest rate hikes.