Euro Near 5 1/2-Month Low Against Dollar as Economy Shrinks

By Anchalee Worrachate and Stanley White

Aug. 14 (Bloomberg) -- The euro traded near a 5 1/2-month low against the dollar after a report showed Europe's economy contracted for the first time since the single currency was introduced almost a decade ago.

The European currency also declined against the British pound on concern the second-quarter data will prompt traders to cut bets on higher interest rates in the 15 countries that share the euro. The 14-day relative strength index of the euro versus the dollar still signaled its losses may be exaggerated.

``The euro might find some support in the near term because the recent moves were overdone, but longer term we expect the currency to weaken against the dollar,'' said Lee Hardman, a currency strategist at Bank of Tokyo-Mistubishi Ltd. in London. ``There's more bad news to come in the euro area.'' The euro will fall to $1.40 in the next 12 months, said Hardman.

The euro traded at $1.4932 at 8:35 a.m. in New York, compared with $1.4919 yesterday. It fell to $1.4816 two days ago, the weakest level since Feb. 26. The euro was at 163.55 yen, compared with 163.43 yesterday, when it reached a three- month low of 161.40. The dollar traded at 109.64 yen, compared with 109.53.

Europe's economy shrank 0.2 percent in the second quarter, after growing 0.7 percent in the first, the European Union's statistics office said from Luxembourg.

`Outright Recession'

The contraction was in line with the median forecast of analysts in a Bloomberg News survey. The German economy, Europe's largest, contracted for the first time in almost four years in the second quarter, the Federal Statistics Office said today from Wiesbaden.

``We expect the euro zone to move into an outright recession,'' said Ian Stannard, a London-based currency strategist for BNP Paribas SA. ``We see a multi-year euro downtrend now developing. And data we are getting is consistent with that view.''

Traders have reduced bets the European Central Bank will raise interest rates a second time this year. The implied yield on the December Euribor futures contract was at 4.95 percent today, compared with 5.04 percent at the end of July.

Further euro declines against the dollar may be limited on concern the financial turmoil and the housing slump in the U.S. may deepen. Bank repossessions in the U.S. almost tripled in July, and foreclosure filings increased 55 percent from a year earlier as falling prices cut homeowner equity, said RealtyTrac Inc., California-based seller of foreclosure data.

Relative Strength

The euro's 14-day relative strength index was at 20.8 today. A reading below 30 typically signals a change in price direction is imminent.

The dollar surged 4.6 percent against Europe's common currency this month, enough to prompt Bank of America Corp. to tell its customers to exit trades betting on more gains. Morgan Stanley still forecasts the greenback will approach a record low by October as the housing slump and credit market losses keep the Federal Reserve from raising interest rates this year.

The yen may rise against the dollar on speculation Japanese investors will repatriate some of their earnings on investments in U.S. Treasuries. The U.S. will pay $38.8 billion in principal and coupons on government debt tomorrow. Japan is the largest foreign owner of Treasuries, according to U.S. government data.

Japanese investors sold 461.3 billion yen ($4.2 billion) more overseas bonds and notes than they bought last week, the second week of sales and the most since the period ended April 18, the Finance Ministry said today in Tokyo.

`Great Chance'

``There's a great chance that the yen will appreciate,'' said Akira Takei, general manager in Tokyo for international bonds at Mizuho Asset Management Co., which oversees the equivalent of $37.3 billion. ``People want to avoid risks. Repatriation will play some part in yen strength as there is some comfort in holding funds in your own currency.''

Any gains in the dollar may be limited by speculation a rebound in oil prices will damp consumer spending in the nation, the world's largest user of the fuel. The dollar has risen 6.7 percent against the euro in the past month as the price of oil slumped more than 20 percent from a record.

Crude oil for September delivery rose 86 U.S. cents to $116.86 a barrel after a U.S. Energy Department report showed a bigger-than-forecast decline in inventories of gasoline.

``The resurgence of oil prices is causing the market to second-guess if the rebound of the U.S. dollar is temporary in nature,'' said Firas Askari, head currency trader at BMO Capital Markets in Toronto.

U.S. Inflation

U.S. consumer prices rose more than forecast in July, indicating Federal Reserve policy makers have reason to be concerned over a pickup in inflation.

The consumer price index climbed 0.8 percent, twice as much as anticipated, the Labor Department said today in Washington. The cost of living was up 5.6 percent in the year ended in July, the biggest jump in 17 years. So-called core prices, which exclude food and energy, also rose more than projected.

The British pound may extend its decline to 192.48 yen after the currency dropped below so-called support at around 211.25 yen, technical analysts at Citigroup Global Markets Inc. said in a research note yesterday. The pound traded at 205.38 yen, from 204.87 yen late yesterday.

Support around the 211.25 yen level is the 55-day moving average and represents an ascending trend line that connects the lows in March, May, July and on Aug. 8, based on Citigroup's chart. Support is where buy orders may be clustered.

To contact the reporters on this story: Stanley White in Tokyo at swhite28@bloomberg.net; Anchalee Worrachate in London at aworrachate@bloomberg.net