* Spain's bank bailout fans fears of debt crisis spreading
* Tensions rise in Korean peninsula; Korean won slumps
* Money market strains add to nervousness
(Adds comment, updates prices, changes byline)
By Gertrude Chavez-Dreyfuss
NEW YORK, May 25 (Reuters) - The euro plunged to an
8-1/2-year low against the yen and neared a four-year trough
versus the dollar on Tuesday, as Spain's weekend takeover of a
small bank fueled fears of systemic risks within the banking
system that could hurt global growth prospects.
A slide in global stock prices and escalating tensions in
the Korean peninsula also drove investors to flock to the yen
and dollar for safety, attracted by the generally stable
financial systems of the United States and Japan and the high
liquidity of their currencies.
"The general fear is that developments in Europe would have
a much broader global impact. Increasingly, market participants
are getting scared and fearful that we may have a repeat of
late 2008," said Camilla Sutton, senior currency strategist at
Scotia Capital in Toronto.
The Bank of Spain on Saturday said it had taken over a
small savings bank, CajaSur. Analysts said the bailout
highlighted weakness in the European banking sector and spurred
worries that more banks may need to be bailed out at a time
when European countries are trying to repair their public
finances.
In early afternoon New York trading, the euro was down 0.3
percent at $1.2322 after coming off a session low at $1.2177.
The euro last week touched a four-year low of $1.2143 on
electronic trading platform EBS <EUR=EBS>.
Sutton said she expects the euro to breach that four-year
low, with $1.18 the next key level.
The euro has lost 7.8 percent against the dollar so far
this month and is heading for its biggest monthly fall since
January 2009 at current prices.
Against the yen, the euro fell to around 108.85 yen
<EURJPY=EBS>, its lowest since late November 2001, according to
EBS. It last changed hands at 110.77, down 0.5 percent.
Tensions on the Korea peninsula also buoyed the dollar and
yen after South Korea's Yonhap news agency said North Korean
leader Kim Jong-il had told his troops to prepare for combat.
The South Korean won <KRW=> fell nearly 5 percent at one point.
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Investors were also on edge after three-month dollar Libor
rates soared to 10-month highs July as banks became more
cautious about lending to European institutions after the
Spanish bail-out over the weekend. []
U.S. two-year swap spreads <USD2YTS=RR> , a key gauge of
financial system stress, rose to one-year highs on Tuesday.
The ICE Futures U.S. dollar index <.DXY>, which tracks the
greenback against a basket of six currencies, rose 0.9 percent
to 86.965.
Against the yen, the dollar fell 0.3 percent to 89.93
<JPY=>. Sterling was down 0.3 percent at $1.4381 <GBP=>.
Growth-linked currencies such as the Australian and New
Zealand dollars retreated. The Aussie dropped 1.2 percent
against the yen <AUDJPY=R> and fell to a 10-month low versus
the U.S. dollar at US$0.8068 <AUD=>.
"Market conditions have been extremely good over the last
year or so and people have built up very large positive risk
positions," said Aroop Chatterjee, senior currency strategist
at Barclays Capital in New York.
"If volatility and risk worsens further, we will see a
continued move by investors to cut those positions."
(Additional reporting by Wanfeng Zhou; Editing by Leslie
Adler)
