By Tom Finn
LONDON (Reuters) - The euro slumped to a five-month low on Wednesday after reports that a possible future Italian government would seek debt forgiveness from European creditors and as the dollar resumed its month-long and powerful rally.
The euro fell as much as half a percent to $1.1783 (EUR=), its lowest since late December, after reports surfaced that Italy's anti-establishment 5-Star Movement and far-right League plan to ask the ECB to forgive 250 billion euros of debt.
The single currency had initially shrugged off the news from Italy but with the dollar restarting its rally, the euro succumbed to selling pressures.
"This news from Italy has contributed to the weakening of the euro against the dollar," said Alvin Tan, an FX strategist at Societe Generale (PA:SOGN).
"Once an Italian government is formed the market will be keen to know the details of the fiscal policy. Are they really going to push for this write-off from the ECB? That's the one big question mark," he said.
The euro also fell sharply against the safe-haven Swiss franc, to a five-week low of 1.1799 francs. (EURCHF=EBS)
The euro had been a top performer in 2018, with traders betting on prolonged dollar weakness because of the United States' trade and budget deficits and investors expecting to allocate more money to the euro zone as its economy strengthens.
Bets that the Federal Reserve will in fact be an outlier in tightening monetary policy among major central banks and signs the euro zone's economy recovery has peaked has unwound that entire euro strength and the currency is now down 1.8 percent in 2018.
The single currency's decline on Wednesday was helped by a resurgent dollar, which hit a five-month high underpinned by gains in long-term U.S. Treasury yields.
The dollar index versus a basket of six major peers rose 0.3 percent to 93.517 (DXY) after rallying to 93.457 overnight, its highest since Dec. 22.
The U.S. currency has gained since mid-April and clawed back its 2018 losses after a reassessment of the path of U.S. monetary policy versus other countries.
Moves by China and the United States to avoid a full-blown trade war have allowed investors to focus on the yield advantage the United States enjoys over other countries.
The dollar rally stalled last week after weaker-than-expected April U.S. inflation data but was lifted on Tuesday when strong U.S. consumer spending numbers sent 10-year Treasury yields (US10YT=RR) surging to a seven-year peak of 3.095 percent.
"Today could see a repeat of yesterday. Momentum would certainly seem to back a further dollar advance with little to stop U.S. 10-year Treasury yields pushing to 3.20 percent," said ING FX strategist Viraj Patel.
The yen barely budged after data showed Japan's economy contracted for the first time in nine quarters during January-March.
The Australian dollar was up 0.3 percent at $0.7491
The British pound was weaker at $1.3471