The euro hit a six-week low against the dollar Friday, heading for a third straight week of losses, after the European Central Bank said banks will repay less than half the expected amount of loans and on uncertainty about Italy's election.
The yen dropped against the dollar and euro, with many investors forecasting further weakness as the Bank of Japan looked set to ease monetary policy further to fight deflation.
Banks will repay 61.1 billion euro ($80.8 billion) of the second round of the ECB's three-year loans next week, far below the 130 billion euro in repayments expected by the market. The smaller amount suggested many banks are still dependent on the ECB.
"The smaller-than-expected payback of loans means the ECB's balance sheet will shrink at a slower-than-expected pace," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington. It "further undermined confidence in the state of recovery in the 17-member bloc."
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The euro fell as low as $1.3144, its lowest since Jan. 10, retreating from a session high of $1.3244 after the German Ifo survey showed a big jump in business morale in Germany, suggesting a brighter outlook for the euro zone's largest economy.
It was last down slightly at $1.3183, with market players reporting supporting bids around $1.3150-60.
Richard McGuire, senior fixed income strategist at Rabobank, said that Italian banks may have held off repaying the loan due to the uncertainty about the result of the Italian election this weekend. Analysts are divided over whether center-left leader Pier Luigi Bersani will be able to form a stable majority capable of pursuing the economic reforms that an uncompetitive Italy needs to exit recession.
Investors were wary about the risk of a fragmented Italian parliament or resurgence by former Prime Minister Silvio Berlusconi, which could hinder the euro zone's third largest economy from fighting its longest recession in 20 years.
A report from the European Commission on Friday that forecast the euro zone economy will contract again in 2013 also weighed on the euro, which fell for a third straight session.
On the week, the euro fell 1.3 percent versus the dollar. The dollar gained momentum after minutes of the U.S. Federal Reserve's latest meeting, released Wednesday, fueled speculation the Fed may start to tighten monetary policy earlier than expected.
Some strategists said they expect the euro to grind lower ahead of the outcome of Italian elections, which is not expected until next week. But they added the currency should find support around $1.3040, near the Jan. 10 low of $1.3037.
Bob Lynch, chief currency strategist at HSBC in New York said technical factors also point to a weaker euro. "The downward shift in momentum indicators, the break below the July 2012 uptrend, and the further shift in relative yield spreads against the euro suggest to us that the risks remain on the downside in the near-term," he said.
Against the yen, the euro rose 0.3 percent to 123.12 yen. The dollar rose 0.3 percent to 93.39 yen, not far from a 33-month high of 94.47 hit last week, but was on pace for a weekly loss of 0.3 percent.
Some market players said the fact U.S. policymakers had not particularly objected to yen weakness, which makes Japan's exports more competitive relative to those of other countries, meant the downtrend could continue.
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"We didn't really realize how aggressive the Japanese officials would get, and we also didn't really sense the U.S. condoning it as much as they did," said John Vail, chief global strategist at Nikko Asset Management. "It could be that they are quite willing to let the yen get to this level. My sense is that the 95-105 yen level is the intended range."
The Australian dollar regained ground after hitting a four-month low of $1.0221 against a broadly stronger U.S. currency on Thursday. It was last up 0.8 percent at $1.0325.