Euro Weakens on Concern ECB May Lower Rates, Move to Buy Debt

By Theresa Barraclough and Ron Harui

May 7 (Bloomberg) -- The euro slid against the dollar on speculation European Central Bank policy makers will lower interest rates today and consider other measures such as buying debt to stimulate growth.

Europe’s single currency declined for a third day against the yen after the yield advantage of two-year German bunds over similar-dated Japanese debt narrowed to the least in almost a week. Australia’s dollar climbed to a seven-month high against the U.S. dollar and the yen after the South Pacific nation’s employers unexpectedly added workers in April.

“Some people expect a dramatic move by the ECB, such as a big purchase of bonds,” said Masafumi Yamamoto, head of foreign-exchange strategy for Japan at Royal Bank of Scotland Group Plc in Tokyo and a former Bank of Japan currency trader. That “is why the euro is suffering.”

The euro weakened to $1.3268 at 7:34 a.m. in London from $1.3334 yesterday in New York. The 16-nation currency traded at 131.06 yen, after falling 0.5 percent. The dollar gained to 98.78 yen, from 98.31 yesterday, when it fell 0.5 percent.

Australia’s dollar climbed 0.9 percent to 74.22 yen, after touching 74.64, and advanced 0.7 percent to 75.34 U.S. cents after a government report showed the jobless rate declined for the first time since August. New Zealand’s dollar advanced to 58.78 U.S. cents from 58.37 cents after the nation’s unemployment rate climbed by less than economists estimated.

Drastic Measures

The ECB will reduce borrowing costs by a quarter-percentage point to 1 percent today, according to all economists surveyed by Bloomberg.

The financial crisis needs “drastic” measures, Athanasios Orphanides, an ECB council member, said in Nicosia on May 5. Orphanides and fellow member George Provopoulos have indicated they may support cutting the target rate below 1 percent and buying debt to pump money into the economy.

Europe’s single-currency may be set for a sudden slide if the ECB announces plans to buy debt at today’s policy meeting, Citigroup Inc. said. The U.S. dollar dropped after the Federal Reserve announced March 18 it would start buying Treasuries to hold down consumer borrowing costs.

“The present euro-dollar setup suggests a non-linear reaction,” Citigroup Inc. analysts led by New York-based Tom Fitzpatrick wrote in a note yesterday. “A dovish surprise looks much more likely to illicit a sharp move to the down side while an as expected outcome may have little material effect.”

The difference in yields between two-year German bunds and Japanese notes shrank to 0.94 percentage point, from 1 percentage point at the beginning of the week, according to data compiled by Bloomberg.

U.S. Jobs Data

Australia’s dollar also gained versus the greenback on optimism the U.S. cut workers at a slower pace in April, after a report yesterday signaled the labor market may be recovering.

“Economic data helped give some support to risk appetite,” Mitul Kotecha, head of global foreign-exchange strategy at Calyon in Hong Kong wrote in a report today. The Australian and New Zealand dollars “will continue to benefit from improved carry appetite, higher commodity prices and easing risk aversion.”

In carry trades, investors get funds in a country with relatively low borrowing costs and invest in another with higher interest rates. The risk is market moves can erase those profits. Australia’s benchmark interest rate is 3 percent, compared with 2.5 percent in New Zealand, 0.1 percent in Japan and as low as zero in the U.S.

ADP Employer Services reported that U.S. companies eliminated 491,000 jobs in April, less than the 645,000 jobs forecast in a Bloomberg survey. A U.S. Labor Department report tomorrow is estimated by economists to show companies and government agencies shed 600,000 jobs last month, compared with 663,000 in March.

Stress Tests

The Japanese yen weakened versus 12 of the 16 most-active currencies on prospects that gains in U.S. stocks will spur investors to buy higher-yielding assets. The results of the stress tests, due out at 5 p.m. in Washington today, will show Citigroup Inc. needs only about $5 billion and JPMorgan Chase & Co. doesn’t need a deeper reserve against losses, people familiar with the matter said yesterday.

“The results of the stress tests don’t look as bad as the markets had feared, so the pessimistic mood is likely to ease,” said Yuji Saito, head of the foreign-exchange group in Tokyo at Societe Generale SA, France’s third-largest bank. “Such improvement in risk appetite will probably be a yen-negative.”

Stocks Rally

Asian stocks advanced, with the MSCI Asia Pacific Index of regional shares adding 2.9 percent and the Nikkei 225 Stock Average gaining 4.6 percent. The dollar-yen had a correlation of 0.85 with the Nikkei 225 Average in the past year, according to data compiled by Bloomberg. A value of 1 means the two move in lockstep. Japanese financial markets were closed from May 4 until today for the Golden Week holidays.

The Standard & Poor’s 500 Index rose 1.7 percent yesterday to the highest since Jan. 6 as Treasury Secretary Timothy Geithner said none of the 19 banks that underwent government stress tests are insolvent and the results will reassure investors and the public that the U.S. financial system is sound.

Losses in the yen were curbed on speculation Japanese exporters purchased the nation’s currency after Golden Week.

“There’s talk that exporters came in to buy the yen versus the euro and the dollar after they returned from the holidays,” said Lee Wai Tuck, a currency strategist at Forecast Pte in Singapore. “That’s why the euro-yen and the dollar-yen have retreated from their highs.”

Japanese exporters said they can remain profitable as long as the yen trades at 97.33 per dollar or weaker, a Cabinet Office survey showed on April 22. The level is stronger than the 104.74 breakeven point companies provided last year, according to the survey.

To contact the reporter on this story: Theresa Barraclough in Tokyo at tbarraclough@bloomberg.net; Ron Harui in Singapore at rharui@bloomberg.net

Last Updated: May 7, 2009 02:44 EDT