Asian shares and the euro fell further on Thursday as doubts deepened about Europe's ability to stop its sovereign debt crisis from spinning out of control, with the region's biggest nations split over the European Central Bank's bond buying role.
The focus of concern is shifting to difficulties in securing funds from money markets, where strains are intensifying due to rising government borrowing costs that have made financial institutions reluctant to buy sovereign bonds and lend to each other for fear of counterparty exposure to euro zone debts.
France and Spain will hold bond auctions later on Thursday, and the results are keenly awaited for clues over whether soaring yields can be capped.
European leaders have failed to clear up doubts about the effectiveness of the region's bailout fund, as it has yet to collect funds, aggravating investor jitters, said Yuji Saito, director of the foreign exchange division at Credit Agricole Bank in Tokyo.
Unless the uncertainty over the European Financial Stability Facility is removed, anxiety will persist, weighing on riskier assets and pushing investors to hoard dollars.
MSCI's broadest index of Asia Pacific shares outside Japan <.MIAPJ0000PUS> fell 0.7 percent, dragged lower by financials <.MIAPJFN00PUS>. Japan's Nikkei stock average <.N225> eased 0.3 percent. <.T>
The euro hovered near five-week lows against the dollar, trading not far off Wednesday's trough around $1.3430, a low not seen since October 10. With technically bearish sentiment, traders eyed next support at $1.3145, hit on October 4 when markets tanked across the board on fears Greece would default.
The dollar <.DXY> as measured against six major currencies rose 0.35 percent. Firmer dollar reflects risk aversion and weighs on commodities. Spot gold fell 0.2 percent while Brent crude futures slipped over $1 earlier on Thursday.
EURO ZONE SPLIT
France, which has become the latest euro zone nation to face market scrutiny over its fiscal deficit despite a top-notch credit rating, called for more aggressive ECB bond purchases.
Germany, however, remains firmly opposed to using the central bank as the lender of last resort, saying it is up to individual governments to put their fiscal houses in order.
Banks have shed their euro zone debt holdings as uncertainty over fiscal reforms in highly indebted euro zone countries has raised the risk of huge losses on their portfolios as prices plunged, and the absence of such key buyers has driven up sovereign borrowing costs sharply.
On Wednesday, 10-year French government bond yields hit their highest level since April at around 3.7 percent as market concerns about government finances spread to the euro zone's second-largest economy, while Italian bond yields rose back above 7 percent.
The yield premium of the French 10-year government bond over German Bunds rose to a euro-era high near 2 percent. French banks are among the most exposed to Italy's 1.8 trillion euros ($2.4 trillion) public debt, holding $416 billion as of end-June.
Spanish 10-year bond yields rose to 6.48 percent on Wednesday, widening the yield premium over Bunds to 470 basis points.
Borrowing difficulties from the markets persisted on Wednesday, with the benchmark unsecured dollar London interbank offered rate hitting a high last seen during a flare-up in the euro zone's problems in the summer of 2010.
Euro/dollar three-month cross currency basis swaps, the cost of swapping euros for dollars, widened to -129.0 basis points, its highest since the collapse of Lehman Brothers in 2008.
While spillover to Asia appeared to remain small, some noted signs that overseas market strains may be spreading to the yen market as three-month euro-yen interest rate futures eased and the spread between the 2-year swap rate and Japanese government bond yields hit its widest since January.
It reflects a dwindling number of lenders in cash markets and there is a global trend for snapping up cash, said a bond trader at a Japanese bank.
Mood was subdued in Asian credit markets, with the spreads little changed on the iTraxx Asia ex-Japan investment grade index.
There is weakness but not too much conviction. The fund flows are positive, cash is building up on the sidelines and very little supplies, said a Hong Kong based trader with a European bank. Traders are flat to short and there is no inventory on the street, so cash bonds will outperform CDS which is tracking equities.
(Additional reporting by Akiko Takeda in Tokyo and Umesh Desai in Hong Kong; Editing by Ramya Venugopal)