Euro, Pound Tumble on Bets Europe's Central Banks to Cut Rates

By Bo Nielsen and Ye Xie

Oct. 22 (Bloomberg) -- The euro fell below $1.28 for the first time since November 2006 and the pound tumbled to a five- year low on speculation European central banks will cut interest rates as the global economy heads for recession.

The single European currency also slid to the weakest in more than four years versus the yen as global stocks declined, reducing demand for higher-yielding assets funded by low-cost loans in Japan. The pound declined to a one-week low versus the euro after Bank of England Governor Mervyn King said the U.K. is probably in a recession.

``The market came to realize that many more rate reductions are needed in Europe,'' said Robert Blake, a strategist in Boston at State Street Global Markets LLC, which has $15.3 trillion in assets under custody. ``Dollar repatriation has much further room to run.''

The euro fell as low as $1.2743 before trading at $1.2867 at 9:50 a.m. in New York, from $1.3063 yesterday. It dropped to 126.29 yen, the lowest since April 2004, and last traded at 127.59 from 103.80 yesterday. Japan's currency rose 1 percent to 99.11 per dollar from 100.14.

The pound dropped to $1.6203, the lowest level since September 2003, and traded at $1.6422 from $1.6706. It also declined for a third day against the euro to 78.80 pence from 78.17.

Emerging Markets

Emerging-market currencies weakened as Argentina's planned seizure of private pension funds stoked concern the nation faces its second default this decade. The government of President Cristina Fernandez de Kirchner proposed yesterday taking control of 10 funds, including units of HSBC Holdings Plc and Banco Bilbao Vizcaya Argentaria SA.

Russia's ruble fell for a sixth day against the dollar to the lowest level in two years, dropping as much as 1 percent to 26.9769. The South Korean won lost 3.2 percent to 1.363.02, Brazil's real dropped 4.6 percent to 2.3462 per dollar, and Mexico's peso declined 3.7 percent to 13.725. Argentina's peso was little changed yesterday at 3.2190 per dollar, as traders said the central bank sold reserves to shore up the currency.

Hungary's forint fell 0.2 percent to 277.75 per euro even after the central bank unexpectedly raised its key interest rate. The Magyar Nemzeti Bank increased the main rate 3 percentage points to 11.5 percent, the highest level in the European Union, in an attempt to curb the currency's declines.

Emerging market-currencies tumbled in the past month as the global economic slowdown led investors to sell assets in developing countries, sending Brazil's real and Mexico's peso more than 20 percent lower.

Currency Derivatives

The declines caught companies investing in currency derivatives, or financial instruments derived from stocks, bonds, loans, currencies and commodities, on the wrong side of the trade.

Vitro SAB, the century-old Mexican glassmaker which sells in more than 45 countries, may be forced into creditor protection because of derivative losses, according to analysts at ING Groep NV and Deutsche Bank AG. Taesan LCD Co., the South Korean supplier of flat-screen parts to Samsung Electronics Co., failed on Sept. 16 because of losses on derivatives.

Brazilian losses on currency derivatives may reach 60 billion reais ($27 billion), Paulo Vieira da Cunha, a former central bank director who is now a partner at New York-based hedge fund Tandem Global Partners, said this month.

The euro extended losses today on speculation efforts by global governments and central banks to revive credit markets will fail to avoid a worldwide recession.

Euro `Expensive'

``Expectations for rate cuts in Europe and the U.K. are growing stronger by the day because of the weak economic outlook,'' said Koji Fukaya, senior currency strategist at the Tokyo unit of Deutsche Bank AG, the world's largest currency trader. ``The euro still looks expensive. Other European currencies are also likely to fall.''

Investors bet the European Central Bank will lower borrowing costs by another 0.75 percentage point by June after cutting the main refinancing rate by a half-percentage point to 3.75 percent on Oct. 8, part of coordinated reductions by major central banks.

The implied yield on the three-month Euribor contract expiring in June fell to 3.15 percent, the lowest level in three years. The yield has been 0.23 percentage point higher than the benchmark rate on average over the past year.

The premium traders demand to buy options granting them the right to sell euros against the dollar rose today to the most in at least five years. The currency's one-month 25-delta risk- reversal rate against the dollar widened to minus 1.48 percent, the most since Bloomberg began collecting data in October 2003. The premium is the amount traders demand for euro puts, which allow for sales, over calls, which grant the right to buy.

`Take Profit'

Citigroup Inc. told its clients to ``take profit'' on its bet on the decline of the euro versus the dollar today, according to a research note written by Tom Fitzpatrick, global head of currency strategy at Citigroup Global Markets in New York. Citigroup initiated the recommendation on Oct. 20, when the dollar was at $1.33 per euro.

The dollar has gained 25 percent since touching a record low of $1.6038 per euro on July 15 on speculation the U.S. currency will benefit as the European economy slows.

U.S. investors have repatriated about $60 billion of the nearly $1 trillion in foreign stocks and bonds purchased since 2003, leaving an ``enormous pool of capital'' that may flow back into the U.S. and bolster the dollar, according to a Oct. 16 note by Citigroup.

Deleveraging Appetite

``What is becoming clear is that the steps taken to shore up the capital bases of the major financial institutions and to provide liquidity may well prove successful, but those steps in themselves will not stem the appetite for deleveraging further,'' Derek Halpenny, head of currency research at Bank of Tokyo-Mitsubishi in London, wrote in a note to clients today.

The British pound fell for a fourth day against the greenback after a report yesterday showed U.K. manufacturing confidence dropped to its weakest level in almost three decades.

``It now seems likely that the U.K. economy is entering a recession,'' BOE Governor King said in a speech to executives in Leeds, England, yesterday. ``The balance of risks to inflation in the medium term shifted decisively to the downside.''

Policy makers voted unanimously to lower the benchmark U.K. interest rate by a half-percentage point to 4.5 percent in an emergency meeting on Oct. 8, according to minutes of the decision released by the Bank of England today in London. The nine-member Monetary Policy Committee said the economy had ``deteriorated substantially,'' which would slow inflation from more than double the 2 percent target.

Pound Outlook

The pound may weaken toward $1.60, wrote Kevin Edgeley, a technical analyst at Goldman Sachs Group Inc. in London, citing weekly and monthly stochastic and trend strength indicators.

The Australian and New Zealand dollars fell after the UBS Bloomberg Constant Maturity Commodity Index yesterday declined toward its lowest level since January 2007 as prices of copper, gold and crude oil dropped. Raw materials account for 60 percent of Australia's exports and 70 percent of New Zealand's.

The Australian dollar weakened 3.9 percent to 66.49 U.S. cents and New Zealand's dollar declined to 59.78 cents.

Traders bet New Zealand's central bank will lower rates by a record 1 percentage point from 7.5 percent tomorrow, according to a Credit Suisse index based on overnight swaps trading.

The yen also rose against all of the major currencies on speculation a slowing global economy will prompt investors to pare holdings of higher-yielding assets funded in Japan.

To contact the reporter on this story: Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net; Ye Xie in New York at yxie6@bloomberg.net