Euro Hits 3-Month Low as Cyprus Bailout Worries Markets

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The euro tumbled to a more than three-month low against the U.S. dollar on Monday after a Cypriot plan to tax bank deposits as part of an EU bailout deal sparked fears the euro zone's larger troubled economies such as Spain and Italy may follow suit.

The weekend move broke with previous practice that viewed depositors' savings as sacrosanct and raised fears that a scramble to withdraw cash could spread to larger states seen as possible bailout candidates.

Both Spanish and Italian bond yields rose.But some analysts said losses in the euro should be contained.

(Read More: Cyprus Bailout 'Disaster' Risks New Euro Crisis)

Cyprus is a very small euro zone economy and many believed the move is a one-off measure that is unlikely to be repeated in other peripheral euro zone countries.

"Cyprus has long functioned as an offshore financial center, particularly for Russians," said Karl Schamotta, senior strategist at Western Union Business Solutions in Calgary. "Few in Italy or Spain expect the same to happen at home, given that their countries do not function as offshore tax havens. A wider bank run will probably require a bigger trigger. Traders are nervous about taking larger short positions, and many are already looking for attractive market entry opportunities."

The euro fell as low as $1.2880 in Asian trade, the weakest since Dec. 10, before paring losses to last trade down 0.9 percent on the day at $1.2954.

The euro slightly trimmed losses after a Greek finance ministry source said the Eurogroup has decided to give Cyprus more flexibility over the bank levy.

The Eurogroup has agreed that depositors with less than 100,000 euros ($129,600) should be protected, the source said. He added that Cyprus should still raise 5.8 billion euros from the levy as planned and that the Cypriot parliament would vote on the rescue package on Tuesday.

Reflecting that nervousness, one-month euro/dollar implied volatilities jumped to 13.33 percent in New York trading from around 7.7 percent on Friday. Euro/dollar one-month risk reversals, which measure the relative demand for options on the euro rising or falling, were showing a growing preference for euro weakness.

Scotiabank chief currency strategist Camilla Sutton said all the technical signals are in "sel" territory in the euro/dollar pair and the relative strength indicator is not yet in oversold territory.

Against the yen, the euro fell 0.9 percent to 123.46 yen, briefly breaking through support at 121.68 yen, its 55-day moving average. It dropped as low as 121.55, the lowest since March 6.

The euro fell 0.1 percent against the Swiss franc to 1.2256 francs and 0.9 percent against the British pound to 85.73 pence.

The dollar dropped as low as 93.45 yen on trading platform EBS, where yen flows are the largest, as investors sold riskier, higher-yielding assets funded by the cheaper Japanese currency.

(Read More: Super Wednesday for World's Central Banks)

On the Reuters platform, the dollar/yen low was 94.03. It later recovered all losses to trade at 95.26 yen, little changed on the day, but more than one yen lower from a 3 1/2-year peak of 96.71 yen struck on March 12.

Analysts said the yen should remain under pressure on bets of more aggressive easing steps from the Bank of Japan and expectations euro zone politicians will be able to reassure markets.

The dollar index, which measures the greenback versus a basket of currencies, rose 0.5 percent to 82.645. An improving economy in the United States has underpinned the dollar in recent weeks.