Monday 14 January 2008

Dollar Falls to 7-Week Low on Bets Fed Rate to Drop Below ECB's

The dollar fell to a seven-week low against the euro on speculation U.S. interest rates will drop below those of the 15 nations that share the euro for the first time in three years.

The dollar extended three weeks of declines as Federal Reserve officials including Chairman Ben S. Bernanke signaled they favor greater ``insurance'' against an economic slowdown amid the slump in the housing market. European Central Bank council member Klaus Liebscher said he sees ``significant'' upside risks to inflation.

``In terms of the subprime crisis, the U.S. has been the center of the storm and it will have to pay,'' said Bilal Hafeez, global head of currency strategy at Deutsche Bank AG, the world's largest foreign-currency trader. ``The euro will continue going higher.''

The dollar fell to $1.4915 against the euro, the weakest since declining to a record low on Nov. 23, and was trading at $1.4895 at 7:20 a.m. in New York, from $1.4776 on Jan. 11. The dollar fell 0.3 percent against the British pound to $1.9626 from $1.9566. It fell the most against the yen since Jan. 2, to 107.46 from 108.84.

The U.S. currency may trade at $1.55 to the euro by the end of the first quarter, said Hafeez, who is based in London. That compares with a median forecast of $1.47, compiled by Bloomberg from reports by 45 strategists and economists. Investment banks including UBS AG, the world's second-biggest currency trader, cut their dollar forecasts last week.

Euro Record

The euro rose to a record against the currencies of the region's 24 biggest trading partners on Jan. 11. It advanced against all but four of the 16 most-active currencies today. The single currency also climbed to a record 75.95 British pence and was recently at 75.89 pence, from 75.52 pence on Jan. 11.

The pound fell against 10 of the major currencies even as a report showed U.K. factories increased prices at the fastest annual pace since 1991 in December. Investors are still betting the Bank of England will cut rates again later this year.

The common European currency extended gains against the dollar after rising beyond $1.4825 and $1.4850, where orders to buy the euro were placed, said Lee Wai Tuck, a strategist at Forecast Pte Ltd. in Singapore. Traders sometimes use automatic instructions to limit losses in case bets go the wrong way.

The dollar fell against 15 of the 16 most-active currencies before a Commerce Department report economists in a Bloomberg News survey say will show retail sales were unchanged in December. The currency dropped for a third consecutive day against the Swiss franc and was trading at 1.0905 from 1.1014.

Bank Writedowns

The dollar also declined amid speculation an unidentified New York-based investment bank may write down as much as $25 billion of assets, strategists at UBS wrote in a note to clients. Citigroup Inc., Bank of America Corp. and Merrill Lynch & Co. may report their worst-ever quarter, beset by $35 billion of writedowns that threaten to crimp profit through 2008.

The euro has risen 15 percent in the past 12 months against the dollar as the Fed cut borrowing costs three times since Sept. 18 to prevent the worst housing slump in 16 years from dragging the economy into recession.

``We're expecting continued U.S. dollar weakness,'' Tobias Davis, senior foreign-exchange dealer at Custom House Global Foreign Exchange in Sydney, said in an interview with Bloomberg Television. ``It really is a concern that growth is grinding to a halt faster than some people expect.''

Futures Bets

Fed funds futures contracts on the Chicago Board of Trade show 66 percent odds the Fed will cut its 4.25 percent target rate for overnight bank loans to 3.75 percent at its Jan. 30 meeting. The odds have risen from 6 percent a month ago. The odds of a decrease to 3.5 percent were 34 percent, compared with zero a week ago. The ECB kept its benchmark rate unchanged at 4 percent last week.

The yield spread between German two-year notes and same- maturity Treasuries was 1.14 percentage points, near the widest since November 2002.

The euro's gains may be limited amid speculation its advance will increase pressure on the ECB to keep interest rates unchanged even as inflation stays above its 2 percent ceiling. It may also decline as some investors bet the slowing economy will help push inflation below target.

European Officials

``We cannot live with a euro at this level with three other currencies which are weak,'' France's European Affairs Minister Jean-Pierre Jouyet said in a Jan. 12 interview in Malta, echoing the views of President Nicolas Sarkozy. Italian Prime Minister Romano Prodi said the day before ``everybody is concerned.'' The three other currencies Jouyet referred to were the yuan, the yen and the dollar.

The economic outlook is ``surrounded by considerable uncertainty'' and growth risks are ``all on the downside,'' European Central Bank council member Michael Bonello said in an interview in Malta on Jan. 11. The ``projections that we have for inflation coming down again close to 2 percent by the end of the year could very well materialize.''

Still, ``significant'' upside risks to inflation remain, the ECB's Liebscher said in an interview with Austria's WirtschaftsBlatt newspaper published today. That ``reinforces the view that the ECB may, at least, not lower rates,'' said Tetsuo Yoshikoshi, a market analyst in Singapore at Sumitomo Mitsui Banking Corp., Japan's third-biggest lender.

The Fed is ``ready to take substantive additional action as needed to support growth and to provide adequate insurance against downside risks,'' Bernanke told the Women in Housing and Finance and Exchequer Club in Washington on Jan. 10.

Volatility Rises

The dollar also fell against the yen as one-month implied volatility for yen options against the dollar rose to 13.43 percent from 12.13 percent late in New York on Jan. 11. Higher volatility may deter so-called carry trades funded in yen as it exposes the bets to greater exchange-rate fluctuation risks.

In carry trades, investors borrow in countries with lower interest rates and invest in those with higher rates, earning the spread between the two. The risk is that currency moves erase those profits.