By Gertrude Chavez-Dreyfuss
NEW YORK, May 2 (Reuters) - The euro fell for a third straight session against the dollar on Wednesday after soft European data fueled fears about a deep and broader slowdown in the region ahead of key elections in France and Greece.
The euro, however, briefly trimmed losses after a report showed the U.S. economy created fewer private-sector jobs than expected last month. It also came off its lows after speculation the European Central Bank could provide euro-zone banks with more liquidity in another long-term refinancing operation.
Wednesday's weaker euro zone data, not just in indebted smaller regional economies but in core nations too, raised speculation over possible policy signals at Thursday's ECB monetary policy meeting.
Italy's manufacturing sector shrank more than expected, with new orders tumbling at their fastest rate in three years. Data from Germany, Spain and France also showed factory activity falling significantly. "Despite liquidity provisions from the ECB, the data shows that the long-term fundamental picture in the euro zone remains negative," said Brian Kim, currency strategist at Royal Bank of Scotland in Stamford, Connecticut. "The weakness seems to be across the board." The euro fell to $1.3121, its lowest in more than a week, though volumes were thin after the May Day holiday in Europe, and traders said this could cause exaggerated moves. The euro last traded at $1.3156, down 0.6 percent.
In the options market, there was reportedly heavy demand for downside protection in euro/dollar, lifting risk reversals, a key measure of currency sentiment, across the curve. For instance, one-month puts in the euro, or bets it will depreciate, traded at 1.60 vols on Wednesday, from 1.50 the previous session. One-year puts reportedly paid 2.7 vols from 2.55 on Tuesday.
Demand for downside protection should increase further if euro/dollar goes below $1.31, traders said.
The euro's weakness propelled implied volatility, a gauge of expected price action, higher as well to 9.0 percent on Wednesday from 8.55 percent as it moved closer to its 50-day moving average.
The ECB meets on Thursday in Spain, with pressure on the bank to use bond buying and other measures to shield weaker euro members from additional pain. While it is widely forecast to keep interest rates unchanged, expectations are rising it may soon cut borrowing costs, eroding the euro's rate advantage.
There was also speculation that the ECB could embark on a third round of cash injections, or LTRO, to provide low-cost liquidity to euro zone banks, a potentially positive scenario for the euro.
RBS' Kim said the re-introduction of the ECB's LTRO program could help the financial system in the near term, but "this would be just prolonging the euro zone's long-term malaise." With elections looming in Europe, political uncertainty has the potential to push the euro below $1.30 in coming weeks.
Francois Hollande, front-runner and first-round winner in the French presidential race, has vowed to shift the debate in Europe towards promoting growth if elected, raising concern about tensions between Germany and France.
The election in Greece is more unpredictable. The two main parties supporting the country's bailout scheme are believed to have a narrow lead to form a coalition over smaller parties opposed to the programme.
The euro also hit a two-week low against the safe-haven yen, dropping to 105.11 yen , and a 22-month low against the British pound. It was further weighed down by data showing the euro zone labor market continued to worsen as unemployment rose to match its record high of 10.9 percent, last seen 15 years ago. The data in the euro zone contrasted with better U.S. factory numbers a day earlier, although Wednesday's weaker-than-expected U.S. private sector jobs data did temper some optimism about the world's largest economy. The ADP report, however, is not necessarily the most accurate forecaster of the broader U.S. nonfarm payrolls data due on Friday.
"After Tuesday's ISM manufacturing data, the market was primed for an upside surprise, so this definitely takes the wind out of the sails," said Boris Schlossberg, director of FX Research, GFT in Jersey City.
The ADP report had a bigger impact on dollar-yen trade, with the greenback giving up some of its gains after the data's release. The dollar was last at 80.220 yen , up 0.2 percent and off a 2-1/2-month low of 79.640 yen hit on Tuesday.
Pressure on the yen increased after a Moody's ratings agency official said Japan's delay in implementing a sales tax increase could bring forward "the day of reckoning" in the Japanese government bond market. Additional Nick Olivari in New York; Editing by Andrew Hay)
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