Euro Falls as Inflation Report May Strengthen Case for Rate Cut

By Ron Harui and Stanley White

Feb. 2 (Bloomberg) -- The euro fell to the lowest level in almost two months against the dollar on speculation a report tomorrow will show European producer prices slid a fifth month, giving the region’s central bank more room to cut interest rates.

The British pound declined the most in almost two weeks on concern the U.K. banking crisis will deepen after Moody’s Investors Service cut its long-term debt rating of Barclays Plc. The yen strengthened for a third day against the dollar before a U.S. report that economists say will show manufacturing fell to the lowest level since 1980, adding to signs the global recession is worsening.

“Inflation is slowing and the eurozone economy is deteriorating,” said Yuji Saito, head of the foreign-exchange group in Tokyo at Societe Generale SA, France’s third-largest bank by market value. “The euro is likely to be sold” to $1.27 and 113 yen today, he said.
The euro dropped to $1.2721 as of 1:58 p.m. in Tokyo from $1.2813 late in New York on Jan. 30. It reached $1.2711, the weakest since Dec. 5. Europe’s single currency slid 1 percent to 114.04 yen from 115.23 yen. The pound declined 1.1 percent, the most since Jan. 20, to $1.4381. Against the euro, the U.K. currency fell 0.4 percent to 88.46 pence.
The yen rose to 89.62 per dollar from 89.92. It climbed 1.2 percent to 56.63 against Australia’s dollar and 1.7 percent to 45.09 versus New Zealand’s dollar. The MSCI Asia-Pacific Index of regional shares slid 2.3 percent.

Producer Prices

The euro fell against 12 of the 16 most-active currencies today. Prices of goods leaving euro-area factories dropped 1.2 percent in December, after a 1.9 percent decline the previous month, according to a Bloomberg News survey before the statistics office report tomorrow.
The odds the European Central Bank will lower its 2 percent main rate by a quarter-percentage point at its Feb. 5 meeting rose to 76 percent on Jan. 30 from 75 percent the day before, according to a Credit Suisse Group index based on swaps.

The pound fell against the dollar for the first time in more than a week on speculation a deepening U.K. banking crisis will prompt the Bank of England to lower borrowing costs.

Barclays, which turned down government funding last year, had its long-term debt rating downgraded to Aa3 from Aa1 by Moody’s yesterday. The rating company cited “potentially significant further losses” as a result of writedowns on credit-market holdings and an increase in impairments.

‘Sell the Pound’ 

“Traders are looking for the chance to sell the pound,” said Saburo Matsumoto, senior manager in Tokyo of foreign- exchange sales at Sumitomo Trust & Banking Co., Japan’s fifth- largest bank by market value. “There are doubts about the health of the U.K. financial system. There’s no denying that U.K. rates are headed lower.”

Sterling may weaken to $1.40 in the next few days, Matsumoto said.

The Bank of England will reduce rates by half a percentage point to 1 percent when it announces a policy decision Feb. 5, according to a separate Bloomberg survey.
Japan’s currency gained for a third day versus the Australian and New Zealand dollars on speculation the U.S. manufacturing report today will spur investors to sell higher- yielding assets funded in Japan.
“The yen is likely to be the strongest currency for some time,” said Tsutomu Soma, a bond and currency dealer at Okasan Securities Co. in Tokyo. “There isn’t much that’s positive about the economic outlook. Investor flows back into the yen are likely to pick up pace.”
The yen may rise to 89.15 per dollar today, Soma said.

Factory Index 

The Institute for Supply Management’s factory index fell to 32.5 in January from 32.9 the prior month, according to a Bloomberg survey. A reading of 50 is the dividing line between growth and contraction.
The VIX volatility index, a Chicago Board Options Exchange gauge reflecting expectations for stock-market price changes that is used as a measure of risk aversion, rose 5.2 percent to 44.84 on Jan. 30.
“Japanese investors tend to repatriate capital during periods of heightened risk aversion,” said Joseph Capurso, a currency strategist at Commonwealth Bank of Australia in Sydney. “The yen could retest the record high of 55 against Australia’s dollar this week.”

Rate Cut 

The Reserve Bank of Australia will cut its benchmark rate by 1 percentage point to 3.25 percent tomorrow, the lowest level since 1964, according to a Bloomberg survey. Benchmark rates are 4.25 percent in Australia and 3.5 percent in New Zealand, compared with 0.1 percent in Japan, encouraging investors to borrow in yen and buy higher-yielding assets elsewhere.
In a carry trade, investors get funds in a country with low borrowing costs and invest in one with higher rates. The risk is that currency market moves erase those profits.
Gains in the yen may be limited by speculation Japanese exporters will lobby the government to intervene by weakening the currency to protect overseas earnings.

“The yen is the most critical problem for exporters,” Masakazu Kubota, a managing director at Keidanren, Japan’s largest business lobby, said in an interview on Jan. 30. “Whether the government does it alone or in cooperation with others, they should do something about the yen,” he said. “Industry is crying out for it.”
Companies from Hitachi Ltd. to NEC Corp. are forecasting losses and firing workers, worsening a downturn the central bank forecasts will be the sharpest in the postwar era.
Policy makers intervene by buying or selling currencies to influence exchange rates. The last time Japanese policy makers intervened, they sold a record 20.4 trillion yen ($227 billion) in 2003 and 14.8 trillion yen in the first quarter of 2004.

To contact the reporter on this story: Ron Harui in Singapore at rharui@bloomberg.net; Stanley White in Tokyo at swhite28@bloomberg.net.
Last Updated: February 2, 2009 00:18 EST