Euro falls as ECB signals rates pause

July 4, 2008

The euro fell the most against the dollar in more than two months after European Central Bank President Jean-Claude Trichet signaled that he may not increase interest rates again.

The 15-nation euro also dropped against the pound and the yen as Trichet said he has ''no bias'' or ''pre-commitment'' following the decision to raise the ECB's main refinancing rate by a quarter-percentage point to 4.25%.

''Trichet clearly sounded more dovish,'' said Emanuele Ravano, managing director and co-head of European strategy in London at Pacific Investment Management, which manages the world's biggest bond fund. ''That is a big change in stance by the ECB. We might have hit a point where the euro doesn't have a lot to stand on.''

The euro dropped 1.2% to $US1.5696 in New York, from $US1.5882 yesterday. It touched $US1.5682, the weakest level since June 26. It rose to the all-time high of $US1.6019 on April 22. Against the pound, the euro deceased 0.6% to 79.19 pence, from 79.70 pence. The dollar appreciated 0.8% to 106.71 yen, from 105.91. The euro fell 0.4% to 167.50 yen, from 168.20.

Today's interest-rate increase will help the central bank bring inflation back below 2%, Trichet said at a press conference in Frankfurt. Economic growth may weaken to 1.5% next year from 1.8% this year and 2.6% in 2007, according to ECB staff.

'To the Sidelines'

''The ECB is moving to the sidelines,'' said Matthew Strauss, a senior currency strategist in Toronto at RBC Capital Markets, a unit of Canada's biggest bank by assets. ''It does not mark a sharp turnaround for the euro-dollar. But it took some steam out of the euro's rally.''

Trichet's comments helped counter a Labor Department report showing US employers eliminated jobs in June for a sixth consecutive month.

Traders reduced bets the ECB will increase rates further this year. The implied rate on the December Euribor interest- rate futures contract fell to 5.12%, from 5.28% yesterday. The yield advantage of two-year German bunds over comparable-maturity Treasury notes decreased to 1.92 percentage points, making the European securities less attractive to investors. The difference was 2.05 percentage points yesterday, the widest since June 6.

Sweden's krona strengthened the most against the euro since January after the Riksbank raised its benchmark interest rate to 4.5% and said it may lift it again. The krona rose 0.7% to 9.4166 per euro.

Fed Reductions

The greenback has lost 11% against the euro since the Fed made the first of seven reductions in the target lending rate from 5.25% in September, helping to drive the price of crude oil to record highs. Chairman Ben S. Bernanke said in early June that he's ''attentive'' to the effect of the dollar's decline on inflation.

Crude oil for August delivery touched $US145.85 today, the highest since trading began in 1983. The euro-dollar exchange rate and oil have moved in the same direction 90% of the time during the past year, according to Bloomberg calculations based on the correlation of their value changes.

''With oil continuing its way to $US150 a barrel, it's hard for the euro to drop,'' said Benedikt Germanier, a currency strategist at UBS. ''The outlook for the dollar is hardly bullish.''

Dollar's Range

The dollar has traded from $US1.53 to $US1.59 per euro in the past two months. The currency must weaken beyond $US1.6020 to break out of the range and head for a decline to $US1.67, wrote Kevin Edgeley, a London-based technical analyst at Goldman Sachs, in a research note. He uses charts to predict currency movements.

US payrolls fell by 62,000 last month, following a revised decline of 62,000 in May, the Labor Department said today in Washington. The median forecast of 81 economists surveyed by Bloomberg News was for a reduction of 60,000. The jobless rate remained at 5.5% after jumping in May by the most in two decades.

''Soft employment will have an impact on consumers,'' said Robert Sinche, head of global currency strategy at Bank of America. ''There's still a good chance we're going to test the old highs,'' he said of the euro.

Futures on the Chicago Board of Trade showed an 18% chance the Fed will increase its target rate for overnight lending between banks by a quarter-percentage point at its August 5 meeting, compared with 25% odds yesterday.

The greenback dropped 1.2% against the euro last week in its second consecutive weekly loss after the Fed gave no indication in its June 25 statement that it will start reversing the most aggressive series of cuts in two decades.

Bloomberg