Euro Rises for Second Day on Speculation ECB Won't Lower Rates

By Gavin Finch and Stanley White

Aug. 28 (Bloomberg) -- The euro rose against the dollar for a second day on speculation the region's interest-rate advantage over the U.S. will draw investors after a European Central Bank official signaled a cut in borrowing costs is unlikely.

The euro is at a four month-high against the British pound after ECB policy makers Axel Weber and Lucas Papademos said yesterday that rates may have to rise as the economy recovers. The U.S. dollar fell for a second day against the yen as oil climbed, threatening growth in the largest energy consumer. The Australian dollar gained after a government report showed second- quarter business investment increased by almost three times as much as forecast.

``There seems to be a concerted ECB drive to correct market perceptions that policy makers are even considering a rate cut and that's supporting the euro in the short term,'' said Kamal Sharma, a currency strategist in London at JPMorgan Chase & Co. ``Given the outlook for U.S. financial institutions there's also reasons to suggest that the dollar looks vulnerable at these levels.''

The euro rose to $1.4778 at 9:17 a.m. in London, from $1.4727 yesterday in New York. The currency traded at 160.90 yen from 161.27. Against the pound, it appreciated 0.2 percent to 80.43 pence, near a record high of 80.99 pence on April 16. The dollar fell to 108.88 yen, from 109.49 yen.

The euro stayed higher after a report showed unemployment fell in Germany in August by an adjusted 40,000, outpacing economists expectations of a 10,000 decline.

Aussie Dollar

The Australian dollar advanced to 86.72 U.S. cents, a second day of gains, from 85.88 cents yesterday after the Bureau of Statistics said capital spending rose 5.7 percent from the first quarter, when it increased a revised 1 percent.

ECB policy makers may need to raise borrowing costs once the economic outlook ``brightens'' toward the end of the year and in 2009, Weber, 51, who heads Germany's Bundesbank, said in an interview in Frankfurt. Papademos, the ECB's vice president, said in a speech in Buenos Aires there's a risk of a wage-price spiral which, if it happens, would ``require a stronger degree of monetary tightening.''

Annual increases in consumer prices of 4 percent for the 15 nations that share the euro are twice the ECB's target of just below 2 percent. The yield spread on two-year German government debt over similar maturity Treasuries widened to 1.73 percentage points from a two-month low of 1.54 percentage points on Aug. 13.

Traders reduced bets that the central bank will cut its 4.25 percent main refinancing rate next year. The implied yield on the Euribor futures contract expiring in September 2009 has risen 9 basis points this week to 4.47 percent. The yield averaged 18 basis points above the ECB's benchmark from 1999 to August 2007.

Dollar Rally

The dollar's rally against the euro over the past month is ``overdone'' and doesn't reflect the outlook for interest rates and economic growth in the U.S. and Europe, according to Bank of Tokyo-Mitsubishi UFJ Ltd.

The correlation between the euro-dollar exchange rate and the implied yield differential on the 90-day Eurodollar futures contract for March 2009 delivery and the corresponding Euribor contract has been weakening. They have had a correlation of 0.97 in the past two years, according to Derek Halpenny, London-based head of currency research at the firm. A reading of 1 would mean they moved in lockstep.

``The very substantial dollar gains of the past month are not justified by the outlook for the U.S. economy,'' said Halpenny. ``The fallout from the collapse of the housing market is in its early stages and will undermine economic growth for some time. Meanwhile, the outlook for the euro region is not as bleak as some are forecasting.''

Oil Rises

Crude oil rose for a fourth day, to $118.70 a barrel, on forecasts Tropical Storm Gustav will strengthen as it enters the Gulf of Mexico, home to 26 percent of U.S. production.

Declines in the dollar may be limited before revisions to the second-quarter gross domestic product report from the Commerce Department today. The U.S. economy expanded an annualized 2.7 percent, faster than preliminary data showing 1.9 percent growth, according to a Bloomberg survey of 78 economists.

``The dollar has gained valuable support,'' said Kengo Suzuki, currency strategist in Tokyo at Shinko Securities Co. ``The U.S. economy looks to be in a better position than other countries as the global economic slowdown spreads.'' The U.S. currency may rise to 110 yen next week, he said.

Losses in the yen may be limited by speculation Japanese investors are repatriating earnings amid concern the U.S. housing slump will worsen.

Repatriating Earnings

Japanese investors' disposals of overseas bonds exceeded purchases by 1.42 trillion yen ($13 billion) in the week ended Aug. 23, the biggest net sales since at least 2001, the Finance Ministry said today in Tokyo. JPMorgan Asset Management Japan Ltd. said last week it was reducing holdings of debt of Fannie Mae and Freddie Mac, the two largest U.S. mortgage financers.

``The global economy is sluggish and Japanese investors can't take on risk and so we've seen them reducing exposure of foreign assets,'' said Yasutoshi Nagai, chief economist in Tokyo at Daiwa Securities SMBC Co., part of Japan's second-largest brokerage. ``I'd expect the yen to continue appreciating for the rest of this year'' to around 105 versus the dollar, he said.

The U.S. Dollar Index's six-week advance may stall at 77.85, based on charts that predict price movements, said Kevin Edgeley, a technical analyst at Goldman Sachs Group Inc. in London.

The rally in the Dollar Index from the middle of July has lost its ``bullish'' short-term momentum and trend strength before reaching its December high of 77.85, Edgeley wrote in a research note yesterday.

The Dollar Index traded on ICE Futures in New York declined 0.4 percent to 76.77, from 77.051 yesterday. It reached an eight- month high of 77.619 on Aug. 26.

The Dollar Index's support levels are at the Aug. 21 low of 76.02 and June 13 high of 74.31, according to the report.

To contact the reporter on this story: Gavin Finch in London at gfinch@bloomberg.net; Stanley White in Tokyo at swhite28@bloomberg.net