Euro Falls to Three-Week Low on Speculation ECB Will Cut Rates

By Ye Xie and Anchalee Worrachate

Jan. 6 (Bloomberg) -- The euro fell to a three-week low against the dollar on speculation slowing inflation will prompt the European Central Bank to cut interest rates more than forecast.

The common currency had a record two-day loss versus the pound and dropped against the yen as derivatives trading showed investors are betting the ECB will cut its key rate by at least 25 basis points next week. The dollar advanced against yen and the Swiss franc after U.S. President-elect Barack Obama was said to favor an economic stimulus package of about $775 billion.

“The market comes to the start of the New Year, increasingly thinking the ECB is in a position to cut interest rates further,” said Tom Fitzpatrick, chief technical strategist at Citigroup Global Markets Inc. in New York. “Interest-rate differentials are moving in favor of the U.S. The bias is toward a stronger dollar.”

The euro fell 1.9 percent to $1.3381 at 8:52 a.m. in New York, from $1.3635 yesterday. It earlier touched $1.3313, the lowest level since Dec. 12. The euro declined 0.8 percent to 126.24 yen, from 127.31. The dollar rose 1 percent to 94.36 yen from 93.44 yen, and touched 94.25 yen, the highest level since Dec. 1.

The yen fell 2.3 percent against Brazil’s real and 1.6 percent versus Mexico’s peso on speculation investors may resume carry trade where they borrow from low-interest-rate countries to buy higher-yielding assets elsewhere.

European Inflation

The currency gained 29 percent against the euro last year as $1 trillion in losses on mortgage-related securities worldwide prompted Japanese investors to shun higher-yielding overseas assets.

The yen’s real effective exchange rate, a measure of its value against the currencies of 15 of Japan’s trading partners after adjustment for inflation, rose 5.1 percent in December from a month earlier to the highest level since November 2001, the Bank of Japan said today in Tokyo.

Europe’s single currency fell 1.3 percent to 91.51 pence. It has lost 4.3 percent this week, the biggest two-day losses since the European currency’s debut a decade ago. Inflation in the euro area slowed to 1.6 percent last month, the European Union’s statistics office in Luxembourg said today. That was less than the 1.8 percent predicted in a median forecast of 28 economists surveyed by Bloomberg. The rate fell to 2.1 percent in November from 3.2 percent the previous month, the biggest reduction since at least 1991.

‘Economic Fundamentals’

“Poor economic fundamentals in euroland warrant further rate cuts from the ECB,” said Paresh Upadhyaya, who helps manage $50 billion in currency assets as a senior vice president at Putnam Investments LLC in Boston. The euro may fall to $1.30 in three months, Upadhyaya said.

At 0.84 percent, the two-year U.S. Treasury yield was 0.88 percentage point lower than the same-maturity German bund. The gap has narrowed from 1.22 at the beginning of December, making the U.S. securities more attractive.

The ECB cut interest rates by 1.75 percentage points since early October to 2.5 percent as the region entered a recession. Policy makers will lower the main rate by at least 25 basis points at the next meeting on Jan. 15, according to a Credit Suisse Group AG gauge of probability, based on overnight index- swap rates.

ECB council member Vitor Constancio said policy makers are prepared to cut interest rates if necessary to keep inflation on target. He said in a speech in Lisbon yesterday that if price growth slows too much below the central bank’s goal of just below 2 percent “we can be certain that European monetary policy will respond with interest-rate reductions.”

Dollar Index

Economists in a Bloomberg survey predicted the central bank will lower borrowing costs to 1.5 percent by the second quarter of next year.

Obama told House Speaker Nancy Pelosi yesterday that he favors a U.S. economic stimulus plan of about $775 billion, a Democratic aide said. The president-elect, who is due to deliver a speech on the economy on Jan. 8, met with congressional leaders from both parties at the Capitol to help win support for a two-year plan to tackle the nation’s recession.

The Dollar Index traded on ICE futures, which tracks the greenback against six of U.S. major trading partners, touched 84.023, the highest since Dec. 12.

The U.S. currency climbed 1.2 percent to 1.1231 Swiss francs today. It also gained versus some emerging market currencies, rising 0.3 percent versus the South African rand and 0.7 percent against the Polish zloty.

Emerging-market currencies are poised for further losses as recessions force wealthier nations to rein in overseas investment, according to Morgan Stanley.

Emerging Markets

One-third of the world’s wealth has been wiped out by the financial crisis and this will have a lasting effect on global consumption, wrote London-based Stephen Jen, chief strategist for emerging markets in the bank’s sales and trading arm. Foreign direct investment in the developing nations of Asia, Europe and Latin America is already starting to cool, he said.

Dresdner Kleinwort said the dollar’s strength was driven partly by a “seasonal pattern.”

“Over the past 10 years, the dollar index had a positive return in January in 71 percent of all cases,” said Michael Klawitter, a currency strategist at Dresdner Kleinwort in Frankfurt. “January or the first quarter is by far the best period for the dollar.” The euro will fall below $1.30 in the “coming weeks,” Dresdner said.

The euro may fall 5.6 percent to 87.50 British pence over the next three months, Standard Chartered Plc forecast, citing technical charts that predict price movements. The euro last traded at 91.29 pence from 92.74 pence.

Daily momentum indicators such as the relative strength index and the stochastic oscillator charts are “turning bearish, favoring downside retracement,” Callum Henderson, head of global currency strategy at Standard Chartered in Singapore, wrote in a research note today.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Anchalee Worrachate in London at aworrachate@bloomberg.net