The euro dipped to a 29-month low against the dollar on Tuesday as the announcement of a snap election in Greece threw the country into a fresh round of political turmoil.
The austerity-minded leading coalition in Greece failed on Monday to secure enough votes in parliament to elect a president, paving the way for an early general election next year.
The markets are now concerned that the leftwing opposition Syriza party may win the election and derail Greece’s international bailout.
After Greece nearly crashed out of the euro in 2012, when it had to accept a bailout in return for austerity measures, the country had just returned to economic growth this year and ended a four-year exile from bond markets.
The euro touched $1.2130, its lowest since August 2012.
The euro’s slip against the dollar has been limited thus far — it was down only 0.2 percent on the day — as the outcome of the Greek parliamentary vote was already priced in by some.
But other participants urged caution, suggesting political turmoil in Greece was only in its early stages.
“Several weeks of opinion polling lie ahead and, as the election date approaches, we should expect the euro to become gradually more sensitive to any apparent shifts in the public mood,» Gareth Berry, a forex strategist at UBS, wrote in a note to clients.
A dip below $1.20 for the euro could be a distinct possibility if the risk, however remote, of a Greek exit from the euro zone re-emerges as it did in 2012, he said.
The Greek political situation adds to the burden placed on the common currency, already weighed by prospects of the European Central Bank implementing further easing measures in 2015 to shore up the euro zone economy and ward off deflation.
“The ECB policy meeting on Jan. 22 of course remains an important euro event, but developments in peripheral euro zone nations like Greece now also need attention,» said Shinichiro Kadota, chief Japan FX strategist at Barclays in Tokyo.
The dollar, on the other hand, pared overnight gains and dipped against the yen on the back of a decline in Tokyo shares.
The dollar was down 0.2 percent at 120.420 yen after gaining 0.3 percent overnight.
“It is the typical dampening of risk appetite that is weighing on stocks and in turn dollar/yen. It could remain a factor for the dollar if equities are unable to recover early next year in wake of the Greek situation,» Kadota at Barclays said.
The Nikkei shed 1.1 percent.
In recent months the dollar has risen in tandem with Japanese stocks as foreign investors in particular sell the yen to hedge their equities positions.
The currency market will look to indicators later in the day such as American consumer confidence data and the CaseShiller housing index that may further highlight the continuing strength of the U.S. economy relative to the euro zone and Japan.
Set to remain a key theme in 2015, the divergence between the Federal Reserve’s path toward rate hikes and stimulative policies in Europe, Japan, and Switzerland have helped the dollar index hit an eight-year high this year.
The Australian dollar edged down 0.1 percent to $0.8120.
The Aussie has shed nearly 9 percent so far in 2014, weighed down by falling global commodity prices and sluggish domestic economic growth.