FOREX-Euro weakens, sold in favour of higher-yielding currencies

Reuters

* Euro approaches last week's 4-month low vs dollar

* U.S./euro zone yield gap widens in dollar's favour

* Euro weaker on crosses, investors use it as funding currency (Recasts, adds comments, changes dateline, previous TOKYO)

By Anirban Nag

LONDON, June 11 (Reuters) - The euro hovered near a four-month low versus the dollar and a 1-1/2 year trough against sterling on Wednesday, with the single currency under pressure due to a widening yield gap between euro zone bonds and their major peers.

A rise in U.S. yields on speculation that the U.S. Federal Reserve could raise interest rates sooner than previously expected has supported the dollar and put pressure on the euro this week.

The single currency has also been pegged back by the European Central Bank cutting interest rates last week, including imposing a negative rate on excess cash deposited with it, and other measures to ward off disinflation.

That has pushed down euro zone money market rates, eroding the euro's yield allure, and leading some investors to use it as a funding currency - one borrowed cheaply to buy a higher-yielding unit.

The euro fell 0.1 percent to $1.3535, nearing a four-month low of $1.3503 set last Thursday soon after the ECB cut interest rates to record lows. It was also down 0.1 percent against the British pound at 80.75 pence, close to an 18-month low of 80.64 pence struck on Tuesday.

The euro set a near seven-month low against the Australian dollar on Wednesday. It was last down 0.25 percent at A$1.4420 . Against the New Zealand dollar, the euro last fetched NZ$1.5834, having shed 1.3 percent this week.

"We are seeing a number of euro/crosses hit lows and among the G3 currencies we are seeing the euro becoming a funding currency," said Jeremy Stretch head of currency strategy at CIBC World Markets.

"Against the dollar, we will see a slow grind towards the $1.35 level where there will be some support from sovereign players. Unless of course the U.S. Treasury yields shoot up, it's going to be a slow move down and not a sprint for the euro."

Jesper Bargmann, head of trading for Nordea Bank in Singapore said that while the euro zone's current account surplus and deleveraging by European banks could lead to some demand for the euro, the currency is likely to head lower in the medium term.

"I think it will be a preferred funding currency in the medium term...." he added.

FOCUS ON YIELDS

The dollar index was steady at 80.817 having gained 0.7 percent so far this month, tracking rising U.S. yields.

According to Thomson Reuters data, the yield spread between two-year U.S. Treasuries and two-year German government bonds has risen to more than 37 basis points this week, its highest in seven years.

"The only theme is a widening in U.S.-European yield differentials," said Daisuke Karakama, chief market economist for Mizuho Bank in Tokyo, referring to the driver of the euro's declines versus the greenback over the past couple of days.

A strong U.S. jobs report on Friday, and hawkish comments from St. Louis Federal Reserve Bank President James Bullard on Monday have given a lift to U.S. yields this week and helped buoy the greenback against the euro.

The euro fell 0.2 percent versus the yen to 138.5 yen , while the dollar was flat at 102.30 yen.

A focal point for the yen is the Bank of Japan's two-day policy meeting on June 12-13. It is likely to keep monetary policy steady at its decision due on Friday and may slightly revise up its assessment on overseas growth.

(Editing by Nigel Stephenson)

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