FOREX-Euro vulnerable; ECB hike factored in

Dated Posted: 2011-07-07

LONDON, July 7  - The euro slipped on Thursday and looked vulnerable to concerns over the euro zone's debt crisis and the risk that the European Central Bank will decline to flag future rises in interest rates later in the day.

The crisis gained fresh legs this week after ratings agency Moody's slashed its rating for Portugal to junk status, fuelling worries Greece's debt problems could engulf other countries within the euro zone.

ECB president Jean-Claude Trichet is likely to be questioned about the downgrade at a news conference following the central bank's rate decision.

The market has already factored in a 25 basis point rise on Thursday, limiting further upside potential for the euro, but will watch closely to see whether Trichet remains hawkish on inflation and flags any further rate rises.

"The rate hike is well priced in and the market has been paring back a little bit of expectations of rate rises from the ECB over the rest of the year," said Jane Foley, currency strategist at Rabobank.

Trichet is also likely to be questioned about the ECB's willingness to accept private sector involvement in restructuring Greek debt, still an unresolved issue that is weighing on investors minds.

"On one hand you have support from the rate hike but unless we get clarity from Trichet the euro is going to be softer. I think we will go back to yesterday's lows," said Foley.

The single currency last traded down 0.1 percent on the day at $1.4300, coming under pressure from selling by macro funds and Middle Eastern names after Moody's also downgraded Portuguese banks' government-guaranteed debt.

Traders said the market was short ahead of the ECB rate decision, making it vulnerable to an initial squeeze, with support around $1.4280, the 61.8 percent retracement of the June 27 to July 4 rally.

A break below that could see the single currency return to $1.4213, the 76.4 percent level. On the upside stops are reported above $1.4370 and $1.4400 and could become the target of any post-hike trading.

The latest bout of pressure on the euro zone periphery pushed Italian bond spreads to their highest since Q4 2008 and many traders say raising interest rates could add to peripheral funding costs, potentially creating more problems for the euro.

"We have growing disparity between the underperforming periphery and the largely resilient core of the euro zone. This disparity is causing a dilemma for the ECB," said Citi analyst Valentin Marinov.

"How they are going to deal with it is what investors will be looking to find out from today's monetary policy meeting I suspect the euro will continue to underperform other risk correlated currencies as a result."

Safe-haven currency the Swiss franc benefited from the flare up in sovereign debt concerns. The euro fell 0.3 percent to 1.1984 francs, within sight of a record low of 1.1800 francs on June 24.

COMMODITY CURRENCY STRENGTH

The dollar was flat against the yen at 80.92 yen, staying within a well-worn range roughly between 79.80 and 81.30.

Against a basket of currencies the dollar slipped 0.1 percent to 75.075, falling to benefit significantly from euro zone woes, with concerns about the United States' own budget deficit praying on investors' minds.

Currencies backed by strong commodities sectors fared surprisingly well in the face of renewed pressure on the euro and a rise in China's interest rates. Analysts suggested China's third hike this year was close to, or even at the end, of its tightening cycle.

"While the euro is suffering on the back of such negative news flow, unlike the 2010 episodes of euro zone debt woes, the risk aversion impact appears to be getting increasingly narrow," said Peter Frank, strategist at Societe Generale.

"Interestingly, even with the announcement of another China policy rate hike, USD, JPY and CHF gains against the commodity bloc currencies were marginal or non-existent," he added.

The Australian dollar recovered from a dip to one-week lows around $1.0655 to last stand near $1.0734 while the New Zealand currency was at $0.8268, was not far off a 30-year peak of $0.8332 set earlier this week.

The Aussie extended its gains further after data showed Australian employment rose by more than expected in June.  

Source:  Reuters