Dollar Falls to Record Low Against Euro on Rate Differential

By Lukanyo Mnyanda and Kosuke Goto

Sept. 12 (Bloomberg) -- The dollar fell to a record low against the euro as investors bet the Federal Reserve will reduce its target interest rate, narrowing the gap between the U.S. and Europe.

The currency declined for a sixth day, the longest losing streak since April, after the National Association of Realtors yesterday cut its home sales forecast, stoking concern the housing slump is spreading. Investors meanwhile added to wagers the European Central Bank will raise borrowing costs by year-end.

``The fundamentals for the dollar remain poor because the Fed's the only major central bank that's likely to cut interest rates,'' said Adam Cole, head of global currency strategy at RBC Capital Markets in London.

The dollar fell to $1.3887 per euro by 7:53 a.m. in New York, after earlier declining to an all-time low of $1.3889. That compares with the previous low of $1.3852 on July 24.

The U.S. currency has fallen more than 7 percent from its highest point this year, reached Jan. 12.

The dollar also slipped to 113.83 yen from 114.27 yesterday, on speculation Japanese investors will trim riskier overseas bond holdings after Prime Minister Shinzo Abe said he will resign.

U.S. existing home sales will fall 8.6 percent in 2007, exceeding the 6.8 percent drop estimated a month ago, according to the National Association of Realtors. New-home sales will probably decline 24 percent on top of an 18 percent drop in 2006. The dollar fell more than 1 percent last week after a government report showed the economy unexpectedly shed jobs in August.

``The Fed should cut rates by a half-percentage point as the economy's outlook has worsened,'' said Masashi Kurabe, currency manager at Bank of Tokyo-Mitsubishi UFJ Ltd. in Tokyo. ``European rates may go up as soon as the markets stabilize. A narrowing interest-rate differential is positive for the euro.''

Buy Orders

The euro's advance against the dollar accelerated because traders had placed automatic orders to buy the currency once it passed the record, said Kenichi Yumoto, senior dealer at Societe Generale SA in Tokyo. It may rise to $1.3920 against the dollar today, he said. Kurabe said the currency may reach $1.39 today.

The dollar slumped to the lowest in more than a month versus the British pound and was recently little changed at $2.0318.

Against the Canadian dollar, the U.S. currency held near the lowest since the end of July, at 96.13 U.S. cents. It fell to the lowest since August 1995 versus Denmark's krone.

Defaults by U.S. companies will more than double in the coming year as investors shun riskier debt, Moody's Investors Service said yesterday. Borrowing costs for high-risk companies are the highest in more than three years after junk bond yields soared to an average 4.79 percentage points more than U.S. Treasuries from a record low of 2.41 percentage points on June 5, according to indexes compiled by Merrill Lynch & Co.

Rate Differentials

The dollar has declined 9 percent versus the euro and 11 percent against Australia's dollar during the past 12 months as the European Central Bank and Reserve Bank of Australia raised rates to 4 percent and 6.5 percent respectively, while the Fed kept its overnight lending rate between banks at 5.25 percent.

Interest-rate futures show 72 percent odds the Fed will lower borrowing costs by half a percentage point to 4.75 percent next week. A month ago, traders expected a quarter-point cut.

The two-year Treasury yielded 3 basis point less than the similar-maturity German note today. The U.S. securities lost their yield advantage for the first time in three years last week as investors speculated on Fed rate cuts.

By contrast, ECB President Jean-Claude Trichet said yesterday there's a risk inflation will accelerate, stoking speculation policy makers will raise rates this year. Annualized euro-region labor costs, an inflation indicator, increased more than forecast in the second quarter, a report today showed.

Dollar's Decline

The dollar may slow its decline after next week's Fed meeting, should policy makers judge the state of the economy doesn't justify further rate cuts, said Gavin Friend, head of currency strategy at Commerzbank AG in London.

``I don't think the pieces are all there for a concerted dive in the dollar,'' Friend said. ``It might take a couple of months for data to confirm more easing is required beyond next week.''

The dollar has slid more than 4 percent against the euro in the past three months.

The yen was supported after Abe said he will resign to end the political deadlock since his ruling coalition lost upper house elections in July.

``Investors are concerned that progress on Japan's reforms will be delayed,'' said Ryohei Muramatsu, manager of Group Treasury Asia at Commerzbank AG in Tokyo. ``It's led to buying of the yen,'' which may rise to 113.50 per dollar today, he said.

Japanese investors sold more foreign bonds than they bought for a third month in August, with net sales of 690.4 billion yen ($6.05 billion), data from the Ministry of Finance showed today. The yen rose 2.4 percent versus the dollar last month.

``Japanese investors' tolerance for risk is decreasing,'' Tomoko Fujii, head of economics and strategy for Japan at Bank of America in Tokyo, said in an interview today. ``Their courage for investing overseas isn't as strong.''

Last Updated: September 12, 2007 07:55 EDT