By Chuck Mikolajczak
NEW YORK, Oct 5 (Reuters) - The euro slumped to a 17-month low against the dollar on Monday as concerns about France's ability to rein in its budget deficit and a sharp bond market selloff last week elevated fears of a potential sovereign debt crisis in the euro zone, while US economic data showed inflation pressures.
French government bonds have come under pressure as expectations of higher policy rates and rising political uncertainty ahead of the 2027 election in France cast
doubt on the ability of the euro area's second-largest economy to put its public finances on a more stable footing.
Euro zone bond yields diverged again, although moves were broadly less pronounced compared to late last week, as investors favored typical safe-haven assets such as German debt over more indebted countries amid mounting inflation and fiscal worries.
The yield gap between French bonds and safe-haven Bunds — a market gauge of the extra compensation that investors demand to hold French debt — widened to nearly 160 basis points on Friday. That gap was the largest since the euro zone's sovereign debt crisis in 2011, and was last down about 4 basis points to 137.
"It just seems to me like the market is rejecting this 2027 budget. There's an election coming up ... who's going to vote for fiscal austerity with elections coming up?" said Erik Bregar, director of FX and precious metals risk management at Silver Gold Bull in Toronto.
"That French story probably is the biggest FX story of the week. On Friday, they were 160 French over Bunds; now it's 135. That probably explains the euro's bounce in the morning off the lows."
The euro was down 0.37% at $1.1211 after falling as much as 0.8% to $1.116, its weakest since May 2025. The single currency is coming off its fourth straight weekly fall against the dollar, during which it has tumbled 3.1%, its longest weekly streak of declines since May 2025.
DOLLAR GAINS ON INFLATION CONCERNS
While market expectations for a rate hike at the Federal Reserve's meeting at the end of the month have dropped considerably, the concerns about euro zone debt and US economic data that continue to point to persistent inflation have buoyed the dollar.
On Monday, the Institute for Supply Management said its nonmanufacturing Purchasing Managers Index fell to 54.9 last month from 55.4 in August, slightly below the 55.2 estimate of economists polled by Reuters but above the 50 threshold that signals expansion. In addition, the survey's measure of prices paid by businesses for inputs jumped to 74.0 from 72.6 in August.
Expectations for a rate hike of at least 25 basis points from the Fed at its October meeting were at 23.8%, according to CME FedWatch, down from 70.9% a week earlier. Expectations for a rate hike in December remain elevated, however, with markets pricing in an 86.8% chance of a hike.
The dollar index, which measures the greenback against a basket of currencies, rose 0.26% to 102.16, after reaching 102.53, its highest level since April 10, 2025, shortly after US President Donald Trump unveiled a tariff package that he dubbed "Liberation Day" and which triggered a broad selloff in US assets.
JAPAN PLEDGES BOND CONTROL
Against the yen, the dollar strengthened 0.09% to 157.97, as recent verbal warnings from the government and authorities against yen depreciation and its safe-haven status have done little to stem the Japanese currency's recent weakness.
Japanese Prime Minister Sanae Takaichi pledged to "control" bond issuance and act swiftly against market turbulence, seeking to reassure investors worried about Japan's worsening public finances who have pushed up bond yields.
A business survey showed that Japan's service sector expanded at a weaker pace in September as business activity and new orders grew more slowly and earthquake disruption dampened demand.
Sterling weakened 0.14% to $1.3223 but was up about 0.2% versus the euro.
(Reporting by Chuck Mikolajczak; additional reporting by Stefano Rebaudo; Editing by Kevin Buckland, Kim Coghill, Jan Harvey, Rod Nickel)
