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Fragile euro set for a political pounding

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Global currency traders have been circling volatile exchange rates this week, with expectations high that political divisions in Europe could lead to further opportunities to generate some return.

Sterling was sent into free-fall on Monday after a date was set for a U.K. referendum on the country's membership of the European Union after the country renegotiated its membership of the 28-country bloc. But experts are increasingly looking at the downside risks for the euro as the European project itself is called into question.

Angela Merkel (L) talks with French President Francois Hollande after their bilateral meeting during a Eurozone emergency summit on Greece in Brussels, Belgium, June 22, 2015.
John Thys | Pool | Reuters

"(Brexit) would have negative growth implications for the rest of Europe and, more importantly, could cause wider political uncertainty," Kit Juckes, global head of foreign exchange strategy at Societe Generale, said in a note on Tuesday morning.

A split for the U.K from Europe - which Citi analysts believe has a 30-40 percent chance of happening - could cause other nations to try to renegotiate their own terms. This at a time when the leaders of the 19-nation euro zone - which share the common currency - are looking at closer political and fiscal union. And also at a time when nationalism has spread across various parts the region following the euro zone debt crisis of 2011.

"The British blackmail strategy may set a worrying precedent for Euroskeptics across the continent. Already, Marine Le Pen's Front National in France and right-wing populist Geert Wilders in the Netherlands are calling on their governments to seek comparable special deals by threatening national referenda," Carsten Nickel, senior vice president at Teneo Intelligence said in a note over the weekend.

Others also believe that cracks in the bloc could be exploited after a British exit. Kathy Lien, at BK Asset Management, told CNBC Monday that a "Brexit" could mean the "dissolution" of the European Union.

Betting against the euro, or "shorting" it and predicting it to fall, is one way that investors can trade the upcoming uncertainty around the vote, according to Lien. She predicts that the single currency can "certainly" trade below the psychological support of 1.10 against the dollar from its current level of 1.1007 at midday London time on Tuesday.

The euro slipped by just under 1 percent on Monday against the dollar after several political heavyweights in the U.K. threw their weight behind the "out" campaign. This wasn't close to the near 2 percent fall for sterling but it's the latest move in a larger trend lower for the single currency as traders ponder whether it can still reach parity with the greenback.

The currency lost 11 percent in 2014 and 10 percent in 2015 on the promise - and then the implementation - of aggressive asset purchases by the European Central Bank. It is still trading at levels not seen since 2003.

SocGen's Juckes suspects that a break of 1.10 will see an acceleration downwards for euro/dollar and predicts that euro/J could see an even bigger move in the short term, even testing the 120 level.