Euro slips on German elections; world stocks weak

By Jeremy Gaunt, European Investment Correspondent

LONDON (Reuters) – The euro weakened on Monday after German Chancellor Angela Merkel’s conservatives were routed in elections in a key state, while world shares eased back after their recent rally.

Wall Street looked set to open flat to slightly higher after the S&P 500 (.SPX: Quote, Profile, Research) had its best week in seven.

Concerns also lingered in equity markets about reports of soaring radiation levels at a damaged nuclear plant in Japan, and about the impact of the fighting in oil-producer Libya, although oil prices slipped back to $115.18 a barrel after rebels regained control of key Libyan oil towns.

Merkel’s conservatives lost power in regional stronghold Baden-Wuerttemberg on Sunday, with early poll results showing the Greens, buoyed by Japan’s nuclear crisis, surging to their first state premiership.

Barclays Capital said in a note that the result meant Merkel, the leader of Europe’s largest economy, would be more reliant on support from opposition parties and that it could feed uncertainty about political support for a euro zone bailout package.

The euro eased against the dollar as a result, down 0.3 percent to around $1.4040 but the dollar was also aided by hawkish comments from some Federal Reserve officials.

“It is a combination of setbacks to German Chancellor Angela Merkel’s party and the U.S. dollar being lifted by those comments from the Fed officials which led some investors to short the euro,” said Adam Myers, senior currency strategist at Credit Agricole.

St. Louis Federal Reserve President James Bullard said on Saturday that lengthening the “extended period” of low interest rates could encourage a liquidity trap.

His remarks followed comments on Friday from Philadelphia Federal Reserve Bank President Charles Plosser, who said the Fed would have to reverse its easy money policy in the “not-too-distant future” to avoid sowing the seeds of inflation.

WEAKER SHARES

World shares as measured by MSCI (.MIWD00000PUS: Quote, Profile, Research) were down around 0.3 percent with the pan-European FTSEurofirst (.FTEU3: Quote, Profile, Research) up 0.1 percent.

Japan’s Nikkei (.N225: Quote, Profile, Research) earlier closed down 0.6 percent.

The slip in global sentiment followed a fairly strong rally last week that belied the overall negative news from disaster-hit Japan and turmoil in the Arab world.

“We had a nice bounce last week. Markets have been resilient in the face of some hideous news,” said Justin Urquhart Stewart, director at Seven Investment Management.

The Western-led military intervention in Libya was allowing rebel forces to gain ground. Syria deployed its army to the country’s main port over the weekend in an attempt to rein in spreading protests across the country, while in Yemen talks stalled between the government and opposition.

The price of crude fell though, with Brent down 50 cents at just over $115 a barrel after Libyan rebels regained control of key oil towns and a rebel official said oil output could be increased.

The price of gold fell nearly 1 percent, pressured by a firmer dollar.

In bond markets, German government bond prices traded lower after the election result.

Yields on Portuguese government bonds, meanwhile, hit new euro lifetime highs after Standard & Poor’s cut the credit ratings of five Portuguese banks.

Yields on five-year bonds jumped to as high as 8.764 percent, putting further pressure on Lisbon to seek an international bailout as it faces snap elections which could make it difficult for Lisbon to finance itself ahead of bond redemptions in April and June.

(Additional reporting by Brian Gorman and Anirban Nag; Editing by Susan Fenton)

Euro slips on German elections; world stocks weak