May 30, 2018 / 7:53 AM / 10 months ago

FOREX-Euro stuck near 10-month lows as Italy's political crisis deepens

* Euro rebounds 0.3 pct after big drop

* Dollar edges off 2018 highs

* Franc pressured by euro recovery

* Graphic: World FX rates in 2018

By Tommy Wilkes

LONDON, May 30 (Reuters) - The euro bounced higher on Wednesday but remained stuck near 10-month lows against the dollar as concerns about a deepening political crisis in Italy kept a lid on any rebound.

The failure to form a new government in the euro zone’s third-largest economy has raised the likelihood of an early election that some market players fear will become a de facto referendum on the single currency and Italy’s role in the European Union.

Sources close to some of Italy’s main parties said there was now a chance that President Sergio Mattarella could dissolve parliament in the coming days and send Italians back to the polls as early as July 29.

After major moves on Tuesday, when a massive sell-off in Italian debt markets rippled into currency markets, the foreign exchanges began European hours on a quieter note, with the dollar edging back slightly from its 2018 highs.

Italian government bond yields settled below multi-month highs after Tuesday’s market turmoil.

The euro, which plunged to a 10-month low of $1.1510 on Tuesday as Italian worries added to bearish sentiment around the single currency, rallied 0.3 percent to $1.1573 on Wednesday.

It has fallen more than 4 percent this month and most analysts remain cautious on its outlook.

“The risk to the euro is predominantly political in the near term,” said Alvin Tan, an FX strategist at Societe Generale, adding that the bank is confident that the euro is capped at $1.15 or $1.16 until the Italian political crisis is resolved.

The euro had dropped 1 percent against the safe-haven Swiss franc on Tuesday, its biggest daily fall since September, but it recovered half a percent to 1.1493 francs as some calm returned to markets.

It is down more than 4 percent this month, the biggest monthly decline since January 2015, when the Swiss central bank suddenly scrapped its floor for the euro against the Swiss currency.

Against the yen, the euro rose to 126.03 yen after hitting an 11-month low of 124.62 yen overnight, from about 131 yen a little more than a week ago.

“‘Don’t try to catch a falling knife’ is the phrase I heard very often today,” said Bart Wakabayashi, Tokyo branch manager at State Street Bank. “For the time being, we will just have to see how things develop.”

The dollar slipped by 0.2 percent against a basket of currencies to 94.631 but steaded against the yen. It had hit a five-week low of 108.115 yen the previous day as the risk-averse mood boosted the Japanese currency.

Investors are also wary of an escalation in trade frictions between the United States and China after the White House said that it still holds the threat of imposing tariffs on $50 billion of imports from China.

Washington said it will use it unless Beijing addresses the issue of theft of American intellectual property.

U.S. bond yields have fallen over the past couple of days, undermining the dollar’s yield attraction and a key reason for the currency’s rapid turnaround in the last month. (Additional reporting by Hideyuki Sano in TOKYO Editing by David Goodman )

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