Euro Falls on Speculation ECB Won't Raise Borrowing Costs Again

By Kim-Mai Cutler

July 5 (Bloomberg) -- The euro fell against the dollar on bets a worsening economic outlook will deter the European Central Bank from increasing borrowing costs again.

The 15-nation currency posted its first weekly decline since mid-June after ECB President Jean-Claude Trichet said he has ``no bias'' following the decision to raise the main refinancing rate by a quarter-percentage point to 4.25 percent. Speculation that he would signal more than one rate increase helped the euro trade as high as $1.5909 this week.

``Trichet was more dovish than the market expected,'' said Daragh Maher, a strategist in London at Calyon, the investment- banking arm of Credit Agricole SA, France's third-biggest lender by market value. ``It had gone looking for too much upside in the euro versus the dollar.''

The euro decreased 0.6 percent to $1.5699 this week, from $1.5794 on June 27. Europe's currency dropped as low as $1.5656 yesterday, the weakest level since June 26, from the all-time high of $1.6019 on April 22. The euro bought 167.73 yen, compared with 167.58 a week ago. The dollar traded at 106.80 yen, compared with 106.13.

Japan's currency fell 2.8 percent this week to 13.79 against the South African rand and 0.4 percent to 102.85 versus the Australian dollar as confidence among Japan's largest manufacturers fell to a four-year low, encouraging investors to borrow in Japan and buy higher-yielding assets elsewhere.

Tankan Index

The Tankan index of manufacturer sentiment slid to 5 points in June from 11 in March, a third quarterly decline, the Bank of Japan said today in Tokyo. Japan's target lending rate of 0.5 percent compares with 12 percent in South Africa and 7.25 percent in Australia.

Trichet played down at a July 3 press conference in Frankfurt the prospects of interest-rate increases, saying this week's quarter-point boost will help bring inflation back below the ECB's preferred limit of 2 percent. Trichet said he had ``no bias'' on further rate moves.

``Trichet has confirmed that the central bank has shifted back to a more neutral stance,'' BNP Paribas SA strategists led by Hans-Guenter Redeker wrote in a research note. ``We believe that interest rates are now on hold, suggesting that further downward pressure on the euro is now likely to develop.''

Traders reduced bets the ECB will increase rates further this year. The implied rate on the December Euribor futures contract fell to 5.15 percent yesterday, from 5.28 percent the day before the ECB's decision.

European Inflation

European inflation accelerated to a 16-year high of 4 percent in May. Economic growth may weaken to 1.5 percent next year from 1.8 percent this year and 2.6 percent in 2007, according to ECB staff.

Growth in the countries that use the euro can improve in the fourth quarter after a slow expansion in the second and third, Trichet said in an interview on Dutch television channel RTLZ, recorded July 3 and broadcast yesterday.

``The second quarter was much less flattering than the first,'' he said.

Annual growth in German industrial production slowed in May to 3.5 percent, from 4.8 percent the prior month, according to the median forecast of 27 analysts surveyed by Bloomberg News. It would be the slowest pace since August 2005. The Bundesbank in Frankfurt will release the data at noon July 7.

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

U.S. Payrolls

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

``We saw a weak euro after Trichet's comments because the market had been very long,'' said Lutz Karpowitz, a Frankfurt- based currency strategist at Commerzbank AG, Germany's second- biggest lender. ``But we also saw some very weak U.S. data. The dollar is going to come under pressure again in the next few weeks.'' A long position is a bet the currency will strengthen.

President George W. Bush said at the White House on July 2 that ``we're strong-dollar people'' before leaders of the Group of Eight begin a three-day summit in Toyako, Japan, next week. The G-8 is made up of Canada, France, Germany, Italy, Japan, Russia, the U.K. and the U.S.

`Dissipating'

``The international community's willingness to accept dollar weakness is dissipating,'' said Russell Jones, global head of foreign-exchange and fixed-income research in London at RBC Capital Markets. ``The dollar's going to gradually recover against the euro.''

Crude oil for August delivery increased 2.8 percent this week to $144.18 a barrel on speculation tension in the Middle East may get worse. Futures climbed to a record $145.85 a barrel on July 3. The euro-dollar exchange rate and oil have moved in the same direction 90 percent of the time during the past year, according to Bloomberg calculations based on the correlation of their value changes.

To contact the reporter on this story: Kim-Mai Cutler in London at kcutler@bloomberg.net

Last Updated: July 4, 2008 18:16 EDT