Euro Rises for Second Day on Speculation ECB Won't Lower Rates

By Stanley White

Aug. 28 (Bloomberg) -- The euro rose against the dollar for a second day on speculation the region's interest-rate advantage over the U.S. will draw investors after a European Central Bank official signaled a cut in borrowing costs is unlikely.

The euro also climbed versus the yen after ECB council member Axel Weber said yesterday that rates may have to rise as the economy recovers. The Australian dollar gained after a government report showed second-quarter business investment increased by almost three times as much as forecast.

``The euro is getting a boost from these hawkish comments from the ECB,'' said Hiroshi Yoshida, foreign-exchange trader in Tokyo at Shinkin Central Bank, Japan's fifth-largest publicly traded lender by assets. ``Investors have been given good reason to start pricing out a rate cut.''

The euro rose to $1.4794 at 1:28 p.m. in Tokyo from $1.4727 yesterday in New York. The currency traded at 161.49 yen from 161.27. The dollar fell to 109.15 yen from 109.49 yen. Europe's currency may rise to $1.4850 today, Yoshida forecast.

The Australian dollar advanced to 86.56 U.S. cents, a second day of gains, from 86.18 cents in Asia yesterday after the Bureau of Statistics said capital spending rose 5.7 percent from the first quarter, when it increased a revised 1 percent.

ECB Hawks

ECB policy makers may need to raise borrowing costs once the economic outlook ``brightens'' toward the end of the year and in 2009, Weber, who heads Germany's Bundesbank, said in an interview in Frankfurt. Council member Klaus Liebscher said in Berlin that ``vigilance is more necessary than ever'' on inflation.

Annual increases in consumer prices of 4 percent for the 15 nations that share the euro are twice the ECB's target of just below 2 percent. The yield spread on two-year German government debt over similar maturity Treasuries widened to 1.75 percentage points today from a two-month low of 1.54 percentage points on Aug. 13.

Traders reduced bets that the central bank will cut its 4.25 percent main refinancing rate next year. The implied yield on the Euribor futures contract expiring in September 2009 rose 11 basis points, or 0.11 percentage point, to 4.43 percent yesterday. The yield averaged 18 basis points above the ECB's benchmark from 1999 to August 2007.

The dollar's rally against the euro over the past month is ``overdone'' and doesn't reflect the outlook for interest rates and economic growth in the U.S. and Europe, according to Bank of Tokyo-Mitsubishi UFJ Ltd.

Dollar Rally

The correlation between the euro-dollar exchange rate and the implied yield differential on the 90-day Eurodollar futures contract for March 2009 delivery and the corresponding Euribor contract has been weakening. They have had a correlation of 0.97 in the past two years, according to Derek Halpenny, London-based head of currency research at the firm. A reading of 1 would mean they moved in lockstep.

``The very substantial dollar gains of the past month are not justified by the outlook for the U.S. economy,'' said Halpenny. ``The fallout from the collapse of the housing market is in its early stages and will undermine economic growth for some time. Meanwhile, the outlook for the euro region is not as bleak as some are forecasting.''

Crude oil rose for a fourth day to reach $118.71 a barrel on forecasts Tropical Storm Gustav will strengthen as it enters the Gulf of Mexico, home to 26 percent of U.S. production. The euro-dollar exchange rate and oil had a correlation of 0.9 in the past year, according to Bloomberg calculations.

U.S. Economy

Declines in the dollar may be limited before revisions to the second-quarter gross domestic product report from the Commerce Department today. The U.S. economy expanded an annualized 2.7 percent, faster than preliminary data showing 1.9 percent growth, according to a Bloomberg survey of 78 economists.

``The dollar has gained valuable support,'' said Kengo Suzuki, currency strategist in Tokyo at Shinko Securities Co. ``The U.S. economy looks to be in a better position than other countries as the global economic slowdown spreads.''

The U.S. currency may rise to 110 yen next week, he said.

Japan's Nikkei English News reported that the U.S., Japan and Europe drew up plans to intervene and strengthen the U.S. currency in March following troubles at Bear Stearns Cos. The countries considered making an emergency statement of intent through the Group of Seven industrial nations, Nikkei reported citing unnamed sources.

Currency Intervention

ECB spokeswoman Eszter Miltenyi and Treasury spokeswoman Brookly McLaughlin declined to comment on the report.

``Traders will be more wary about selling the dollar,'' said Tsutomu Soma, a bond and currency dealer at Okasan Securities Co. in Tokyo. ``While officials didn't intervene earlier this year, we have a clear sign of how far they're willing to go to prevent the dollar from going into freefall.''

Losses in the yen may be limited by speculation Japanese investors are repatriating earnings amid concern the U.S. housing slump will worsen.

Japanese investors' disposals of overseas bonds exceeded purchases by 1.42 trillion yen ($13 billion) in the week ended Aug. 23, the biggest net sales since at least 2001, the Finance Ministry said today in Tokyo. JPMorgan Asset Management Japan Ltd. said last week it was reducing holdings of debt of Fannie Mae and Freddie Mac, the two largest U.S. mortgage financers.

``The global economy is sluggish and Japanese investors can't take on risk and so we've seen them reducing exposure of foreign assets,'' said Yasutoshi Nagai, chief economist in Tokyo at Daiwa Securities SMBC Co., part of Japan's second-largest brokerage. ``I'd expect the yen to continue appreciating for the rest of this year'' to around 105 versus the dollar, he said.

To contact the reporter on this story: Stanley White in Tokyo at swhite28@bloomberg.net

Last Updated: August 28, 2008 00:37 EDT