Euro drops after German ZEW survey, sterling outperforms

By Anirban Nag

LONDON (Reuters) - The euro fell on Tuesday, after Germany's ZEW survey suggested a shaky start for Europe's largest economy in the third quarter while lingering problems about Portugal's largest listed bank kept investors wary of the single currency.

Portuguese 10-year bond yields rose as shares in Banco Espirito Santo <BES.LS> fell more than 10 percent, with investors worried about the bank's exposure to the troubled companies of its founding family.

So far, there are few signs that these troubles are spilling over to other southern European countries. Nevertheless, they reminded investors that the banking sector and debt troubles in Europe are far from over.

The euro fell to a one-week low against the dollar, dropping to $1.3587. It was down 0.1 percent lower against the yen at 138 yen and 0.5 percent weaker against the British pound, with sterling getting a boost from a jump in UK inflation.

Germany's investor morale survey was the highlight in the European session. ZEW's survey of economic sentiment fell to 27.1 in July, its lowest in 1-1/2 years and missing consensus for a reading of 28. A separate gauge of current conditions fell to 61.8 from 67.7 in June, undershooting forecasts.

"The ZEW was pretty disappointing," said Jeremy Stretch, head of currency strategy at CIBC World Markets. "But for the euro/dollar to head lower, we clearly need something from Yellen."

Investors are awaiting the congressional testimony from Federal Reserve Chair Janet Yellen later in the day. They will examine Yellen's remarks for clues on the timing of interest rate rises, after U.S. data in the second quarter signaled the economy was gaining momentum.

Private-sector jobs and non-farm payrolls growth in June were better than economists had expected and the unemployment rate fell to a near-six-year low of 6.1 percent. But wage inflation is still subdued, giving ammunition to policymakers to keep rates lower for longer.

STERLING SHINES

The euro's losses were much deeper against the British pound which outperformed after data showed a jump in UK inflation.

Consumer prices rose 1.9 percent on the year in June, the Office for National Statistics said, beating expectation for a 1.6 percent reading.

Sterling surged to a day's high of $1.7147 after the data from $1.7078 beforehand, up 0.3 percent and within touching distance of a near six-year high of $1.1780 hit earlier this month. The euro fell to a one-week low of 79.27 pence from 79.755 beforehand, down 0.5 percent.

"Clearly the better way to short the euro is against the pound as it captures the divergence in monetary policy outlook," added CIBC's Stretch.

The inflation data adds pressure on the BoE to tighten policy. In contrast, the euro zone is still grappling with disinflation and the ECB is likely to keep policy accommodative.

The yen held its ground after the Bank of Japan sounded some cautious notes on growth but stopped well short of hinting at a new bout of money-printing.

Governor Haruhiko Kuroda told reporters Japan was only halfway to meeting the 2 percent price target and the bank would maintain the quantitative easing program until the target was met. He added there was no reason for the yen to strengthen.

The dollar was flat at 101.55 yen, well off last week's seven-week low of 101.06 yen.

"The BOJ have essentially backed off the idea of quantitative easing for now but are sending some cautious signals on growth," said Simon Derrick, head of currency strategy at BNY Mellon.

(Additional reporting by Patrick Graham editing by Nigel Stephenson and Ralph Boulton)