Saturday, February 2, 2008

Dollar Approaches Record Low Against Euro After Fed Rate Cuts

By Ye Xie and Bo Nielsen

Feb. 2 (Bloomberg) -- The dollar fell for a second straight week against the euro after the Federal Reserve lowered its benchmark lending rate by a half-percentage point to 3 percent and indicated further cuts in borrowing costs may be needed.

The dollar pared its weekly loss yesterday as an expansion in manufacturing offset the first U.S. decline in jobs in four years and traders balked at bidding the euro above the all-time high. The European Central Bank is forecast to hold its main refinancing rate at a six-year high of 4 percent next week, maintaining the advantage over the Fed's target.

``It looks like the U.S. economy will be slowing at a faster pace than other global economies, clearly dollar- negative,'' said Michael Woolfolk, senior currency strategist at the Bank of New York Mellon in New York.

The dollar dropped 0.8 percent to $1.4802 per euro this week, from $1.4681 on Jan. 25. The U.S. currency came yesterday within a half-cent of the November low of $1.4967 per euro, the weakest level since Europe's currency debuted in 1999. Against the yen, the dollar fell 0.2 percent to 106.49, from 106.72. The euro increased 0.6 percent to 157.67 yen, from 156.68.

The U.S. Dollar Index traded on ICE Futures in New York, which tracks the dollar against six major currencies, fell 0.69 percent this week to 75.45. On Nov. 23, the day the dollar reached the record low versus the euro, the index dropped to 74.48, the weakest level since the gauge started in 1973.

BOJ's Rate

Japan's currency fell 3.2 percent against the New Zealand dollar and 2.6 percent versus the Australian dollar this week as a rally in U.S. stocks prompted investors to borrow in Japan and sell the yen to buy high-yielding assets.

The Bank of Japan's 0.5 percent target lending rate is the lowest among industrialized countries. New Zealand's benchmark is 8.25 percent, while Australia is forecast by economists to increase its target to 7 percent from 6.75 percent next week. In the carry trade, investors get funds in a country with low borrowing costs and buy assets where interest rates are higher. The risk is that fluctuating exchange rates can erase profits.

The Standard & Poor's 500 Index climbed 4.9 percent this week, trimming its yearly loss to 5 percent. The Dow Jones Industrial Average gained 4.4 percent this week.

Payrolls Report

Futures traders increased their bets to the highest level since 2004 that the yen will gain against the U.S. dollar, figures from the Washington-based Commodity Futures Trading Commission show. The difference in the number of wagers by hedge funds and other large speculators on an advance in the yen compared with those on a drop, known as net longs, was 52,928 on Jan. 29, compared with net longs of 41,842 a week earlier.

The dollar dropped yesterday as low as $1.4949 against the euro after the Labor Department reported U.S. payrolls fell by 17,000 last month after an 82,000 gain in December that was larger than initially reported. After erasing its losses, the dollar rose against the euro on an Institute for Supply Management report showing manufacturing expanded in January.

The Fed on Jan. 30 lowered benchmark interest rates by a half-percentage point, eight days after a three-quarter-point emergency reduction, capping the fastest easing of monetary policy since 1990.

Fed Rate Outlook

The U.S. currency has declined 14 percent during the past 12 months as lower interest rates made dollar-denominated assets less attractive to international investors.

``The uptrend in the euro against the dollar is over because you have already priced in a lot of Fed easing,'' said Larry Kantor, head of research in New York at Barclays Capital Inc. and a former Fed economist.

Interest rate futures contracts on the Chicago Board of Trade show a 70 percent chance the central bank will cut the benchmark rate a half-percentage point by its March 18 meeting and 26 percent odds of a quarter-point reduction.

The ECB will keep its main refinancing rate at 4 percent at a policy meeting on Feb. 7, all 55 economists predicted in a Bloomberg News survey.

While interest-rate futures showed traders expected the ECB to lower its target rate in the second half, ECB council member Nicholas Garganas said on Jan. 31 that the central bank won't consider a rate cut because inflation remains ``a major concern.''

The implied yield on the three-month Euribor contracts expiring in July was 3.925 percent yesterday. That rate averaged 18 basis points more than the ECB's benchmark from 1999 until August, when the collapse of the U.S. subprime-mortgage market sparked a squeeze on credit.

The euro will trade at $1.48 by the end of the first quarter, and drop to $1.40 by year-end, according to the median forecast of 44 economists surveyed by Bloomberg News.

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