Euro slides as economy sinks deeper into recession

By Anooja Debnath

(Reuters) - The euro fell to a three-week low against the dollar and dropped against the yen on Thursday after data painted a grim picture of the euro zone economy as it struggles with the debt crisis now in its fourth year.

Output in the 17-country euro zone slid by 0.6 percent in the last three months of 2012, more than the 0.4 percent decline expected in a Reuters poll and deepening its recession.

The bloc's two largest economies, France and powerhouse Germany, also shrank by more than expected in the final quarter, casting doubt on forecasts of a recovery in early 2013.

That bolstered inflows into safe-haven German Bunds and fanned expectations the European Central Bank will lower interest rates in the next few months.

ECB Vice President Vitor Constancio said negative interest rates - where banks effectively pay the central bank to hold their cash securely - were still a possibility, although no decision has been made.

The euro was down 1 percent on the day against the dollar, hitting a three-week low of $1.3315, well below a one-week high of $1.3520 struck on Wednesday and moving further away from its 15-month high of $1.3711 hit on February 1.

Support was cited at around $1.3260, its 55-day moving average, with stop-loss sell orders below that.

Against the yen, the euro fell to as low as 124.01 yen. It was last trading down more than 1 percent at 124.29 yen.

"There are quite a few people out there who are nervous about the scales the euro has gone to and then this morning's growth data kicked it all off (euro losses)," said Neil Mellor, currency strategist at Bank of New York Mellon.

"This is however a periodic sell-off. Right now people will look to buy on the dip unless there is more bad data."

Mellor said although the euro would not see a sustained fall just yet, at some point this year it could nurse consistent losses, judging by the fundamentals in the euro zone.

While financial conditions in the euro zone have shown an improvement and figures earlier in the year from Germany showed some signs the economy was stabilizing, peripheral euro zone countries have continued to struggle in the face of tough austerity measures.

Thursday's data also showed the recessions in Italy, Portugal and Greece had worsened.

"The GDP numbers were weaker than expected and while it's not dramatic, going forward if data continues to weaken and does not reflect the improved financial conditions, we may see some monetary policy response from the ECB," said Paul Robson, currency strategist at RBS.

Those worries are likely to pin the euro down, he said.

The euro has risen 1 percent against the dollar and 9 percent against the yen this year after banks repaid some crisis loans to the ECB, effectively tightening liquidity while other major central banks have been printing more money.

G20 IN FOCUS

Investors will stay cautious on the euro given the risk of a tough statement on currencies from a G20 summit in Moscow this weekend. Speculation has continued that Japan might come under pressure to slow the yen's slide.

The Group of Seven nations said this week that fiscal and monetary policies must be directed at domestic economies and not at targeting exchange rates.

But confusion reigned after a G7 official said the statement was aimed at Tokyo, a comment that prompted the yen to surge on a volatile foreign exchange market. Other G7 countries later said it should be taken at face value.

Against the yen, the dollar, was down 0.1 percent at 93.30, well below a 33-month high of 94.465 set on Monday.

Earlier, the Bank of Japan kept policy steady as expected and revised up its assessment of the Japanese economy. Some believe the bank may hold off on expanding stimulus next month and wait until its first rate review under a new governor, scheduled for April 3-4.

(Additional reporting by Anirban Nag; Editing by Hugh Lawson)