Euro Declines as Drop in Inflation Adds to ECB Cut Speculation

By Ye Xie and Andrew MacAskill

Nov. 28 (Bloomberg) -- The euro weakened the most against the dollar in almost three weeks as investors added to bets the European Central Bank will cut interest rates after inflation in the region slowed by the most since at least 1991.

The euro fell versus the pound the most since January 2001 and declined against the yen and the Brazilian real. Russia’s ruble had its biggest weekly decline against the euro in at least five years as the central bank let the currency depreciate and raised interest rates to halt an exodus of foreign capital.

“The ease of inflation cemented the market expectations for a 50-basis-point rate cut from the ECB next week,” said Jack Spitz, managing director of foreign exchange at National Bank of Canada in Toronto. A basis point is 0.01 percentage point. “The dollar is favored as a safe-haven destination.”

The euro dropped 1.7 percent, the most since Nov. 11, to $1.2691 at 5:13 p.m. in New York, from $1.2904 yesterday. It’s up 0.8 percent this week. The dollar gained 0.4 percent to 95.52 yen, from 95.19 yesterday, and has declined 0.5 percent this week. The euro weakened 1.4 percent to 121.22 yen, from 122.89 yesterday, trimming a weekly gain to 0.4 percent.

The ruble slumped 1.8 percent to 27.913 per dollar and depreciated 0.2 percent to 35.469 per euro. For the week, it lost 1.5 percent against the dollar and 2.3 percent versus the euro, the biggest decline since Bloomberg began collecting the data in December 2003.

Russia, India

Bank Rossii widened the ruble’s trading band for the second time this week by about 30 kopeks (1 U.S. cent), or 1 percent, on each side, according to Mikhail Galkin, head of fixed-income and credit research at MDM Bank in Moscow. The central bank said today it will raise its benchmark refinancing rate to 13 percent from 12 percent to help stem currency losses.

India’s rupee fell the most in two weeks, losing 1.4 percent to 50.1075 per dollar, after terrorist attacks across Mumbai left at least 124 people dead. Authorities closed stock, bond, commodity and currency markets yesterday. The rupee has lost 1.3 percent this month.

The Thai baht declined for a third day, reaching 35.56, the lowest level since February 2007, as protesters occupied Bangkok’s international airport for a fourth day.

The euro fell 1.5 percent to 82.52 pence, the biggest drop since Jan. 3, 2001, after the European Union statistics office in Luxembourg said inflation in the region slowed to 2.1 percent in November from 3.2 percent in October. A separate report showed unemployment in the region rose to 7.7 percent in October from 7.6 percent in September, the highest level since January 2007.

‘Least Resistance’

Investors added to bets the ECB will cut its main refinancing rate about 75 basis points by March from 3.25 percent. The implied yield on three-month Euribor futures contracts expiring in March fell one basis point to 2.67 percent today. The yield averaged 16 basis points above the ECB’s benchmark over the past year.

The ECB will cut its benchmark lending rate by half a percentage point to 2.75 percent on Dec. 4, according to the median of 56 economist forecasts in a Bloomberg News survey.

“The ECB has to come to the party, and they have to be aggressive cutting rates,” said Lane Newman, a director of currency trading at ING Financial Markets LLC in New York. “To buy the dollar is the path of least resistance. You’d better be prepared for a worse-than-expected time ahead.”

The dollar gained versus the euro and the yen today as investors bought the U.S. currency to rebalance their portfolios at the end of the month, said Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York.

‘Dollar Demand’

“There’s a lot of dollar demand at the month-end,” said Franulovich. “The market is confident that the ECB will cut at least 50 basis points next week. That’s the recipe for a stronger dollar.”

The ICE’s Dollar Index, which tracks the greenback against the euro, the yen, the pound, the Canadian dollar, the Swiss franc and Sweden’s krona, rose 1.1 percent to 86.52. The index climbed to 88.463 on Nov. 21, the highest since April 2006.

The dollar posted is first weekly decline against the euro this month on speculation policy makers’ steps to spur growth and lending will reduce demand for the relative safety of U.S. assets. The Federal Reserve said on Nov. 25 it will assign $800 billion in new funding to bolster credit flows to homebuyers, consumers and small businesses and will take on credit risk by buying debt.

Investors should buy the euro versus the greenback because repatriation of U.S. investments abroad and demand for dollar funding is waning, according to Bank of America Corp.

‘Weak Foundation’

The Fed’s support of financial markets will flood the economy with excessive dollars, creating “additional downside risks” for the U.S. currency, strategists David Powell and Robert Sinche wrote in a research note today.

“The recent advance of the dollar rests on a weak foundation,” Powell and Sinche wrote. “The rapid expansion of a country’s monetary base should prove to be inconsistent with a strengthening of its currency.”

The dollar may weaken to $1.4180 per euro, a 50 percent retracement of its rally from a record low of $1.6038 in July to a 2 1/2-year high of $1.233 in October, they wrote.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Andrew MacAskill in London at amacaskill@bloomberg.net
Last Updated: November 28, 2008 17:20 EST