* Euro retreats as short-covering momentum fades
* Tighter funding seen supporting demand for dollar
* Month-end selling by Japanese exporters weighs on euro/yen
By Rika Otsuka
TOKYO, May 26 (Reuters) - The euro fell on Wednesday,
slipping back towards a four-year low against the dollar and an 8
1/2-year trough against the yen as concerns about the health of
the euro zone's banking sector weigh on the single currency.
Signs of tighter funding, with costs for banks to borrow
dollars in the interbank market soaring to 10-month highs, are
driving investors to the relative safety of the U.S. dollar and
away from riskier assets and currencies, traders said.
U.S. two-year swap spreads <USD2YTS=RR>, a key gauge of
financial system stress, also widened to one-year highs on
Tuesday. They slipped off that peak on Wednesday, but are still
about 6 basis points wider for the week. []
"Nothing has changed since yesterday. The money market strain
is there," said a FX trader at a Japanese trust bank. "That is
making players in the currency market very nervous and reluctant
to take risks."
Month-end selling from Japanese exporters helped drag the
euro lower against the yen, traders said.
The euro fell 0.5 percent to $1.2285 <EUR=>, staying above
Tuesday's low of $1.2177, which was not far from a four-year low
of $1.2143 struck last week.
The euro has lost over 7 percent against the dollar so far
this month and is heading for its biggest monthly fall since
January 2009.
The euro fell 0.4 percent against the yen to 110.79 yen
<EURJPY=R>. The European single currency fell as low as 108.83
yen on Tuesday on trading platform EBS, its lowest since late
November 2001.
Traders said credit tightness had been much less severe than
was seen after the Lehman shock in 2008.
But fresh memories of the global credit crunch are making
financial institutions cautious about lending to those who may
have big exposure to debt-ridden countries or banks in the euro
zone, they said.
The Bank of Spain said on Saturday it had taken over a small
savings bank, CajaSur. Analysts said the move highlighted
weakness in the European banking sector and heightened worries
that more banks in the euro zone may need to be bailed out. That
is likely to see more investors fleeing the euro.
The U.S. dollar index <.DXY>, which tracks the dollar against
a basket of six currencies, edged up 0.1 percent to 86.844.
Against the yen, the dollar stood at 90.19 yen <JPY=>, little
moved from late on Tuesday in New York.
Investors generally flock to the yen and the U.S. dollar when
risk aversion and volatility spikes.
JAPANESE MARGIN TRADERS
"The best hope for stability will come when cyclical exposure
has been wound down, but the latest IMM and Japanese retail data
suggest that these liquidations have further to run," JP Morgan
said in a report.
Data suggests the recent sell-off in growth-linked currencies
is likely to run further.
JP Morgan said the latest data from the Commodity Futures
Trading Commission show long positions in the Australian dollar
and the Mexican peso have fallen by two-thirds. For the Canadian
dollar they have fallen by only half.
In addition, Japanese margin traders' net long positions in
the Australian dollar have touched a record high this month.
Tensions on the Korean peninsula are also likely to keep
traders away from the Australian dollar, which is hugely
leveraged to the Asian growth story.
The Aussie dollar fell 0.4 percent to $0.8236 <AUD=D4>,
having earlier rallied from a 10-month low of $0.8066 hit on
Tuesday.
Against the Japanese currency, the Australian dollar fell 0.8
percent to 74.25 yen <AUDJPY=R>.
A trader at a major Australian bank said some Japanese
investors sold the Aussie in early Asian trade.
At the same time, Japanese margin traders were looking for a
chance to hunt bargains in the Australian dollar, which was
likely to limit its slide, said Tsutomu Soma, senior manager of
the foreign securities department at Okasan Securities.
(Additional reporting by Masayuki Kitano and Kaori Kaneko in
Tokyo, and Anirban Nag in Sydney; Editing by Edwina Gibbs)
