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FOREX-Euro set for biggest drop in two weeks on German PMI miss, yields

Saikat Chatterjee

* Graphic: World FX rates in 2019

LONDON, March 22 (Reuters) - The euro tumbled more than half a percent on Friday below the $1.13 level as a big miss in German manufacturing survey data and falling bond yields prompted traders to cut their positions.

The sharp drop in the single currency, its biggest fall in two weeks, rippled over to other currencies and yanked the dollar higher which had struggled throughout the Asian session.

While policymakers had cut growth forecasts for the euro zone economy earlier this month and launched a new round of cheap loans to its banks, the below than expected data raised concerns that the German economy, Europe's powerhouse, may be slowing quickly.

IHS Markit's flash composite Purchasing Managers' Index measuring activity in German services and manufacturing, which together account for more than two-thirds of the economy, fell to 51.5, it lowest reading since June 2013.

"The data was bad and the falling bond yields is also weighing on the euro," said Manuel Oliveri, a currency strategist at Credit Agricole in London.

The single currency fell 0.7 percent to a 10-day low at $1.1288. Against the yen, it fell nearly a percent.

Germany's 10-year government bond yield was poised to turn negative for the first time since October 2016 and was last trading at 0 percent after falling three basis points overnight.

The drop in the euro pulled the dollar higher against a broad basket of its rivals where the euro forms the dominant component. It was trading 0.3 percent higher at 96.71.

Sterling bounced after suffering its biggest daily drop overnight so far this year in the London trading session after Prime Minister Theresa May bought a bit more time to resolve when and how Britain exits from the European Union.

Despite the rise, currency derivative markets signaled a growing caution the outlook for the British currency with one-month risk reversals on the pound versus the euro and the dollar plunging to multi-month highs.

Risk reversals, a gauge of puts to calls, and an indicator of how bearish or bullish are on the outlook of the currency, indicate that short term negative bets on the pound are piling up rapidly despite the broader calm in the spot markets.

One-month risk reversals on the pound versus the euro plunged to its lowest levels since mid-2017. Against the dollar, bearish bets grew to their highest levels since September 2017, according to Refinitiv data.

European Union leaders on Thursday gave May two weeks' reprieve, until April 12, before Britain could crash out of the bloc if lawmakers next week reject her Brexit plan for a third time.

Broader cash markets painted a broader picture of calm despite the underlying nervousness building up in the derivative markets. The pound was up by a third of a percent at $1.3154 and 0.2 percent at 86.57 pence.

"That means the FX market clearly now sees a higher likelihood of sterling collapsing, even if the spot rate is not yet reflecting an increased no-deal risk," Commerzbank strategists said in a note.

(Reporting by Saikat Chatterjee; Additional reporting by Daniel Leussink in TOKYO; Editing by Angus MacSwan)