Euro Falls Versus Dollar as Report Indicates Recession Deepened

By Bo Nielsen and Ron Harui

Jan. 2 (Bloomberg) -- The euro fell against the dollar and the yen after a European manufacturing report showed the recession is deepening in the 16-nation region.

The euro, which yesterday became the currency of Slovakia, headed for its first weekly decline in more than a month on prospects the European Central Bank will cut its target lending rate from 2.5 percent to spur spending. Europe’s PMI index fell to 33.9 in December, below a preliminary estimate of 34.5 and the lowest since the start of the data in 1998.

“The euro zone’s growth outlook is significantly weaker than in the U.S., and that will ultimately weigh on the euro,” said Hans-Guenter Redeker, the London-based global head of currency strategy at BNP Paribas SA, France’s biggest bank. “The ECB will realize that it’ll have to cut interest rates to 1 percent in 2009.”

The euro declined 1 percent to $1.3899 at 7:31 a.m. in New York, from 1.4045 yesterday. Europe’s currency fell 0.2 percent to 127.19 yen from 127.41, after sliding 22 percent last year. The dollar rose 0.5 percent to 91.23 yen from 90.74 following a 19 percent drop in 2008.

European Factories

The European currency will fall to $1.20 by the end of June, Redeker predicted. The euro region’s economy will contract 2.5 percent in 2009, while the U.S. economy will shrink 1.8 percent, he forecast.

Europe’s PMI index is based on a survey of purchasing managers by Markit Economics. A reading below 50 indicates a contraction. The German index fell to 32.7, below the preliminary estimate of 33.5.

Sterling weakened 1.2 percent to $1.4506 against the dollar and 0.4 percent to 96.01 pence per euro after reports showed U.K. manufacturing shrank last month at close to the fastest pace in at least 16 years.

The euro’s 10 percent gain versus the dollar last month may “prove unsustainable given the negative implications renewed euro strength is likely to have on the euro-zone economic growth outlook,” wrote Lee Hardman, a currency strategist at Bank of Tokyo-Mitsubishi Ltd. in London, in a note to clients today. “A return to more normal liquidity conditions in January will signal a partial reversal of recent euro strength.”

The ECB will lower its main refinancing rate to 1.5 percent by the second quarter of this year, a Bloomberg survey predicts. The central bank cut the rate by 1.75 percentage points since October, the first reductions since June 2003, after a global credit crisis helped trigger the euro region’s first recession in 15 years.

Yield Spread

The yield advantage of two-year German bunds over similar- maturity Treasuries narrowed to 0.97 percentage point from 1.09 percentage points two weeks ago, indicating concern Europe’s economy will weaken further, data compiled by Bloomberg show.

The euro’s 14-day relative strength index versus the dollar climbed above the 70 threshold in mid-December, signaling its recent gains were hard to sustain, and fell to 58.59 today, Bloomberg data show.

“Momentum funds are buying some dollars,” said Lee Wai Tuck, a currency strategist at Forecast Pte Ltd. in Singapore. “There are views that the dollar has been oversold.”

Dollar gains may be limited as near-zero interest rates in the U.S. damp global demand for the greenback, hampering the government’s efforts to finance stimulus packages, according to DBS Group Holdings Ltd., Southeast Asia’s biggest bank.

“You do see a bias returning for a weaker dollar,” said Philip Wee, a senior currency economist at DBS in Singapore.

Dollar Index

The ICE’s Dollar Index, which tracks the U.S. currency against the euro, the yen, the pound, the Canadian dollar, the Swiss franc and Sweden’s krona, dropped 6 percent in December, the first monthly decline since June. It has since risen 0.2 percent to 81.491.

The Federal Reserve cut its benchmark interest rate to a range of zero to 0.25 percent for the first time last month and shifted its focus to debt purchases to support the economy. The U.S. budget deficit swelled to $164.4 billion in November, widening for nd month, official figures show.

The yen rose for the first time in four days against Australia’s dollar, advancing 1.1 percent to 63.33. Australia’s 4.25 percent main interest rate compares with 0.1 percent in Japan. The yen was little changed at 52.84 versus New Zealand’s dollar.

The yen may strengthen in 2009, after last year advancing against all of the 16 most-traded currencies, tracked by Bloomberg peculation tighter credit conditions will prompt investors to reduce holdings of higher-yielding assets funded in Japan’s currency.

“Risk-taking appetite is unlikely to increase, so there’s a bias for yen appreciation,” said Masashi Kurabe, head of currency sales and trading in Hong Kong at Bank of Tokyo- Mitsubishi, a unit of Japan’s largest publicly traded bank by assets.

To contact the reporters on this story: Bo Nielsen in Copenhagen at bnielsen4@bloomberg.net; Ron Harui in Singapore at rharui@bloomberg.net
Last Updated: January 2, 2009 07:34 EST