FOREX-Euro rally proves temporary despite relief over Italian budget
* Italian yields slide on ratings decision, Rome comments
* Euro gives up rally against dollar, holds vs Swiss franc
* Chinese stimulus expectation boosts market sentiment
* Graphic: World FX rates in 2018 (Adds quotes, details, updates prices)
By Tommy Wilkes
LONDON, Oct 22 (Reuters) - The euro failed to holdearly-session gains on Monday as investors focused on thelikelihood of further political uncertainty in Europe overItaly's spending plans, despite a large drop in Italiangovernment borrowing costs.
Rating agency Moody's downgraded the Italian credit ratingon Friday but unexpectedly kept the outlook at stable. That, along with more conciliatory comments from Italianofficials that they were ready to sit down with European Unionofficials and did not intend to expand the deficit beyond 2019,boosted demand for Italian debt after a weeks-long sell-off.
But the euro, its fortunes increasingly linked this year toItalian bond prices, failed to hold on to early gains anddropped from $1.1550 to $1.1511, down 0.1 percent from the open."We have more conciliatory tones from both sides but it isstill clear that this dispute is not over yet," Commerzbankanalyst Thu Lan Nguyen said.
"We are expecting volatile markets," she said, noting thatinvestors would be looking to Thursday's European Central Bankmonetary policy meeting to see whether, while unlikely, the bankwould comment on the dispute.
Other analysts also said the euro remained at the mercy ofItalian developments, with a great deal of uncertainty ahead.
"... A full diary of risk events over the next two weeks andlittle to argue in favour of support from the ECB in the nearfuture, the question remains over how far the yield gap can blowout and how this could translate back into the FX market," BNYMellon chief currency strategist Simon Derrick said.
The single currency was able to hold on to gains elsewhere,rising 0.1 percent to 1.1474 Swiss francs, and 0.3percent versus sterling to 88.300 pence.
The dollar index rose 0.1 percent to 95.782.
CHINA BOOST
Equity markets were mostly positive as hopes that China'stax cuts next year could be worth more than one percent of grossdomestic product sparked a rally in Asian shares that fed acrossto Europe.That helped offset geopolitical concerns about the riftbetween Saudi Arabia and the West over the killing of aprominent critic of the kingdom, as well as worries aboutBritain securing an exit deal with the EU.
Although the more positive tone at the start of the week didboost sentiment, forex markets were largely quiet.
The Australian dollar, which tends to benefit when Chinasentiment improves because of its exposure to Chinese demand,dropped 0.2 percent to $0.7105 .
Elsewhere, the dollar rose versus the Japanese yen.The yen fetched 112.82, down 0.3 percent on the day and off aone-month high of 111.61 touched on Oct. 15. Geopoliticalconcerns helped it to benefit from its safe-haven status.
The Canadian dollar changed hands at C$1.3087, withinstriking distance of a five-week low of C$1.3132 hit on Fridayon the back of weaker inflation and retail sales. Sterling traded 0.2 percent lower at $1.3034 asmarkets prepared for British Prime Minister Theresa May's latestBrexit speech scheduled for Monday.
(Editing by Louise Ireland)
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