The euro fell to a four-month low against the dollar on Wednesday and was poised for more losses after Greece announced it would hold new elections, boosting the risk the country could exit the euro.
The prospect of prolonged political instability and worries about the knock-on effects of a Greek euro exit for struggling economies like Spain and Italy caused investors to flee the euro and seek the safety of the dollar and the yen.
The euro also hit a three-month low against the yen, while the dollar rose to its highest in four months against a basket of currencies.
“The uncertainty around the political situation in Greece continues to undermine risk appetite, which is affecting a range of currencies,» said Paul Robson, currency strategist at RBS.
“There is uncertainty around the willingness of the euro zone paymasters to keep a country in the euro if it doesn’t like fiscal austerity. It seems unlikely that Greece can back out of austerity and stay in the euro.”
The euro, which has lost more than 4 percent so far this month, dropped to $1.2683 on EBS trading platform. This left it on course to test the low hit in January of $1.2624, below which would mark the euro’s lowest level since August 2010.
It also fell to 101.904 yen before recovering to trade just above $1.27 against the dollar and above 102 yen. Traders cited buying by hedge funds and institutional investors, but they said the broader trend for euro weakness remained intact.
“Expecting a new Greek currency to fall, the Greek people will start shifting funds to safer assets abroad. The Portuguese and the Irish may also start to think they should do so as well. This is going to create huge uncertainty,» said a Japanese bank trader in Tokyo.
Greek political leaders will meet on Wednesday to form a caretaker government to lead the country into its second election, likely in mid-June, after the failure of last-ditch negotiations to form a technocrat government.
Fears that Greece could leave the euro sent Spanish and Italian government bond yields higher as investors worried that this could set a precedent for other highly indebted countries, while European shares fell more than 1 percent.
However, traders were wary of bouts of short-covering which could send the euro temporarily higher as net shorts in the currency are at three-month highs.
“The market is very short euro, the currency seems oversold by any technical measure, and yet it keeps extending losses – this means that we may quickly approach the $1.25-$1.26 area,» said Koji Fukaya, director of global foreign exchange research for Credit Suisse Securities in Tokyo.
With the appetite for risk dampened, investors kept piling into assets deemed as safe, helping the dollar index rise to 81.573, its highest since mid-January.
The greenback also performed well against the yen, rising to a two-week high of 80.45, roughly one yen above the 2-1/2 month low of 79.428 yen hit last week.
Traders said the pair may extend its rise, citing stop-loss bids around 80.45-50. The dollar also rose to a four-month high against the Swiss franc of 0.9471 francs.
Risk aversion and worries about slowing global growth also weighed on higher-yielding currencies like the Australian and New Zealand dollars, which fell to five-month lows against the U.S. dollar.