Euro Drops as Europe Leaders Outline Bank Aid, Rule Out a Bigger ECB Role

By Candice Zachariahs and Monami Yui - Oct 24, 2011 9:06 AM GMT+0700

The euro fell, halting a four-day advance, as European leaders seeking to contain a debt crisis that started in Greece outlined plans to aid banks and ruled out using the European Central Bank to boost the rescue fund.

The 17-nation currency also weakened on speculation banks and lawmakers will struggle to agree on how much to write down holdings of Greek debt, while a complete blueprint for the bailout plan won’t emerge until another summit on Oct. 26. The dollar traded 0.7 percent from a record low versus the yen on prospects the Federal Reserve will consider a third round of securities purchases to boost U.S. economic growth.

“You still have question marks and those question marks will remain for some time to come, particularly around the haircuts” on Greek debt for banks, said Robert Rennie, chief currency strategist in Sydney at Westpac Banking Corp., Australia’s second-largest lender. “It’s logical still to run with a sell bias on the euro.”

The euro slipped 0.3 percent to $1.3859 as of 11:03 a.m. in Tokyo, from $1.3896 on Oct. 21 in New York, when it rose 0.8 percent. The 17-nation currency fell 0.2 percent to 105.76 yen. The dollar fetched 76.32 yen from 76.29 last week, when it reached a post-World War II low of 75.82.

Crisis Summit

Europe’s 13th crisis-management summit in 21 months also explored how to strengthen the International Monetary Fund’s rescue role. The leaders excluded a forced restructuring of Greek debt, sticking with the tactic of enticing bondholders to accept losses to help restore the country’s finances.

“Work is going well on the banks, and on the fund and the possibilities of using the fund, the options are converging,” French President Nicolas Sarkozy told reporters during a break in the Brussels summit yesterday. “On the question of Greece, things are moving along. We’re not there yet.”

Banks offered to write down 40 percent of their Greek debt while politicians are demanding a so-called haircut of at least 50 percent, Reuters said, citing an unidentified banker.

Bank capital needs -- estimated at 100 billion euros ($139 billion) by a person familiar with the deliberations -- will be met first by banks themselves, then by national governments, the European agreed. Only when national efforts fail can governments tap the main 440 billion-euro European Financial Stability Facility for cash to channel to banks.

Germany pushed through one of its main summit aims, defeating French efforts to boost the rescue fund by enabling it to borrow potentially limitless sums from the independent central bank. Policy makers are headed toward using the EFSF to guarantee government bond sales as a way to extend its reach. A second option is to set up an EFSF-insured fund that would seek outside investment in troubled bonds.

Is It Enough?

“You’re always going to be left questioning whether 440 billion euros is enough,” said Westpac’s Rennie. “It’s all very well talking about a special purpose vehicle raising money from outside investors; who are those investors going to be? And what size will that special purpose vehicle get to? It all remains to be seen.”

The dollar maintained last week’s 1.2 percent loss against the yen after Fed Vice Chairman Janet Yellen said on Oct. 21 that a third round of large-scale securities purchases might become warranted to boost a U.S. economy. Pacific Investment Management Co., which oversees the world’s largest bond fund, said today that Fed stimulus is now likely.

The Fed will start by changing its language before taking steps to bolster the economy, seeking to stabilize the housing market, Scott Mather, Pimco’s head of global portfolio management, said at a briefing today in Sydney.

The U.S. economy probably expanded by 2.5 percent in the third quarter, according to the median forecast of analysts surveyed before the government releases its first estimate on Oct. 27. The Commerce Department reported a 1.3 percent annual pace of expansion in the second quarter and a 0.4 percent rate in the first three months of the year.

‘Weak Dollar’

“There’s focus back towards a weak dollar,” said Greg Gibbs, a currency strategist at Royal Bank of Scotland Group Plc in Sydney.

Demand for the dollar was also limited after Bank of America Corp.’s Merrill Lynch unit said the U.S. government’s credit rating probably will be lowered again this year as the so-called super committee fails to produce a credible plan to rein in budget deficits.

U.S. Recession Risk

While the impact of a downgrade may not be as severe as the reaction in August when Standard & Poor’s cut the U.S.’s credit grade, such an action is among the reasons that the risks of a recession next year are increasing, Merrill Lynch economists said in a note to clients.

The dollar was the worst performer over the past month among the 10 developed-nation peers tracked by Bloomberg Correlation-Weighted Currency Indexes, sliding 3.3 percent. The euro was down 0.5 percent while the yen fell 2.9 percent in the same period.

The yen trimmed earlier gains after Japanese Finance Minister Jun Azumi said he will take “decisive” action on the Japanese currency if needed.

He told reporters in Tokyo today he’s watching markets closely as there have been speculative moves.

The Australian dollar dropped against all of its 16 major peers after a report from the Bureau of Statistics showed today that producer prices rose in the third quarter at the slowest pace this year.

The so-called Aussie fell 0.3 percent to $1.0344 and 0.3 percent to 78.94 yen.

-- Editors: Rocky Swift, Naoto Hosoda

To contact the reporters on this story: Candice Zachariahs in Sydney at czachariahs2@bloomberg.net; Monami Yui in Tokyo at myui1@bloomberg.net

To contact the editors responsible for this story: Rocky Swift at rswift5@bloomberg.net