Euro Falls to Six-Month Low as Rate Increase Expectations Fade

By Ye Xie and Candice Zachariahs

Aug. 9 (Bloomberg) -- The euro dropped the most in more than three years this week, pushing the currency to a six-month low against the U.S. dollar, as traders pared bets the European Central bank will raise interest rates as the economy slows.

The currency fell the most in almost eight years yesterday, dropping below $1.50 for the first time since February, after ECB President Jean-Claude Trichet said Aug. 7 economic growth will be ``particularly weak'' through the third quarter. Crude oil fell to a three-month low, silver reached its cheapest since January and copper fell to its biggest weekly drop since May 2007, easing inflation concerns.

``What we have seen over the last few days is the recognition in Europe, in Australia, all around the world, that growth is slowing everywhere,'' said Mohamed El-Erian, co-chief executive officer of Newport Beach, California-based Pacific Investment Management Co., in a Bloomberg Radio interview. ``The euro is no longer as attractive as people once thought.''

Europe's shared currency fell 3.6 percent to $1.5005 yesterday, from $1.5564 on Aug. 1, the biggest weekly decline since January 2005. The currency tumbled 2.08 percent yesterday, touching $1.499, in what the second biggest one-day decline since the introduction for the euro in 1999.

Against the yen, the European currency slumped 1.3 percent to 165.38 yesterday, from 167.55 on Aug. 1. The dollar rose 2.3 percent to 110.18 yen, and touched 110.36 yesterday, the strongest since Jan. 2. It was the biggest weekly gain since the five days ended June 13.

Moving Average

The euro's decline below $1.53 and the break of the 200-day moving average at $1.5226 ``marks a significant change in sentiment for the dollar,'' pointing to a further decline to $1.46, Kevin Edgeley, a London-based technical analyst at Goldman Sachs Group Inc., wrote in a report yesterday. It was the first time the euro fell below the 200-day moving average since 2006.

Since reaching a record high of $1.6038 on July 15, the euro has dropped 6.4 percent. The so-called trading envelopes, which measure how far from the mean a price has strayed, show the euro's decline has doubled the typical changes versus the dollar in the past 20 days.

``The most important aspect of the dramatic collapse in the euro dollar is the absence of confirmation from other markets,'' said David Woo, global head of currency strategy at Barclays Capital Inc. in London yesterday. ``None of the typical drivers of the euro-dollar in the past couple of years could have accounted for the magnitude of this move, which leads one to conclude that this is a technical-driven move. From that point of view, we do not think that this move is sustainable.''

`Undervalued'

The euro is about 2.5 percent ``undervalued'' against the dollar, according to Barclay's models, Woo wrote in a research note to clients yesterday.

The Dollar Index on the ICE futures exchange reached 75.903 yesterday, the highest since Feb. 21.

Pacific Investment Management's El-Erian said the U.S. government's efforts to support Fannie Mae and Freddie Mac will lead to greater Treasury issuance and a weaker dollar. ``It's ultimately inflationary as long as the global economy doesn't collapse,'' he said yesterday.

South African's rand led losses among the most-traded currencies yesterday as the prices of gold and platinum dropped, reducing prospects for export earnings from the country's biggest exports. The greenback rose to a six-month high against the Australian dollar, and advanced to the highest since September against the New Zealand dollar on speculation the central banks will cut borrowing costs.

Russian Ruble

Russia's ruble fell by the most in 2 1/2 years against a dollar-euro basket used by the government after Georgia's Interior Ministry said four Russian fighter-jets entered Georgian airspace and bombed the towns of Gori and Kareli, boosting the risk of war. The ruble dropped as much as 0.8 percent yesterday against the basket.

The pound fell below $1.93 for the first time since March 2007 as the Bank of England kept its main interest rate steady at 5 percent on Aug. 7 after inflation accelerated and the economy teetered on the brink of a recession. It has dropped 2.7 percent this week to $1.9216, its biggest weekly drop in three years.

Trichet said Aug. 7 he has ``no bias'' or ``pre- commitment'' toward future rate movements after the central bank left the main refinancing rate at 4.25 percent. He told reporters in Frankfurt that while inflation remains a threat, risks to economic growth are ``materializing.''

European retail sales dropped by the most in at least 13 years in June, the European Union said on Aug. 5. Consumer confidence slid in July by the most since the Sept. 11, 2001, terrorist attacks, the European Commission said July 30.

`New Chapter'

``This is the beginning of a new chapter for the dollar as Trichet and other central banks are paying more attention to the downside risk to growth,'' said Dustin Reid, a senior currency strategist at ABN Amro Bank NV in Chicago. ``The decline of oil prices is a significant driver behind this dollar rally because it enables other central banks to turn their eyes away from inflation and focus on growth.''

Traders pared bets the ECB will lift rates a second time this year after increasing its main rate by a quarter-point last month. The implied yield on the December interest rate futures, an indication of expectations, retreated 1 basis point to 4.95 percent yesterday.

Crude oil, metal and crop prices fell yesterday as the dollar climbed, reducing the appeal of commodities as a currency hedge. Oil has declined to $115.06 a barrel since touching the record of $147.27 on July 11.

The euro-dollar exchange rate and oil have had a correlation of 0.9 in the past year, according to Bloomberg calculations. A reading of 1 would mean they moved in lockstep.

To contact the reporters on this story: Ye Xie in New York at Yxie6@bloomberg.net; Candice Zachariahs in New York at czachariahs1@bloomberg.net