Euro Buckles Under Expectations That an Old Practice of Slash and Burn Will Befall Interest Rates

ZIRP here we come

March 5 (Bloomberg) — The euro fell, snapping two days of gains versus the yen, on speculation the European Central Bank will cut interest rates today and signal further reductions in borrowing costs to counter the region’s deepening recession.

The euro also headed for a fourth weekly loss versus the dollar before a report from the European Union’s statistics office that economists say will reiterate the region’s economy shrank the most in at least 13 years last quarter. The yen traded near the weakest in four months against the dollar after a government report showed Japanese companies slashed spending at the fastest pace in a decade.

ECB President Jean-Claude Trichet “may say he’ll cut rates again in the future,” said Michiyoshi Kato, senior vice president of foreign-currency sales in Tokyo at Mizuho Corporate Bank Ltd., a unit of Japan’s second-largest bank by assets. “This would likely cause selling of the euro.”

The euro declined to $1.2603 as of 11:19 a.m. in Tokyo from $1.2661 late in New York yesterday. The European currency dropped to 125.16 yen from 125.52. The yen traded at 99.31 versus the dollar from 99.15 yesterday when it touched 99.49 yesterday, the weakest level since Nov. 10. The U.S. currency was at $1.4145 per pound from $1.4194, and advanced to 1.1726 Swiss francs from 1.1676.

The ECB will cut its 2 percent target lending rate by a half-percentage point to the lowest level since the 16-nation currency was introduced in 1999, according to the median forecast of analysts surveyed by Bloomberg News. The Bank of England will halve its main rate to 0.5 percent at a separate meeting today, according to another Bloomberg survey.

Investment Slump

The ECB left borrowing costs unchanged at its most recent policy review on Feb. 5. The euro weakened as much as 0.4 percent against the dollar and 1 percent against the yen when the ECB reduced rates by half a percentage point on Jan. 15.

The yen fell for a third day versus the dollar after the Ministry of Finance said spending by Japanese businesses on capital equipment excluding software slid 18.1 percent in the fourth quarter, the steepest drop since the three months ended Dec. 31. 1998. That was the seventh straight decline.

“Recently the sensitivity is high to bad data so the yen will be under pressure and the risk is for the downside,” 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. “The yen bear trend will continue” and the currency may test 100 per dollar today, he said.

Monthly Loss

Japan’s currency fell 7.9 percent versus the dollar in February, the biggest monthly decline since August 1995, after reports showed the economy shrank last quarter by the most since 1974 and the trade deficit increased in January to the widest since at least 1980.

The decline in the yen against the greenback may be limited as a technical indicator showed the 8.2 percent slide in Japan’s currency over the past month is excessive.

“Even if the dollar goes up to 100, there’ll be profit- takers, or a strong resistance,” said Satoru Ogasawara, foreign-exchange analyst and economist in Tokyo at Credit Suisse Group AG. “At this point, the long positions of the yen have been unwound, so any declines won’t be that significant.”

The dollar’s 14-day relative strength index versus the yen, a comparison of magnitudes of gains and losses, climbed to 75.2 today, above the 70 level that signals the currency may have risen too quickly and is poised to decline.

The yen is likely to strengthen to 93 per dollar by the end of June, according to the median estimate in a weighted Bloomberg survey of economists and analysts.

China Stimulus

Gains in the dollar may be tempered after Premier Wen Jiabao said China will “significantly increase” investment to tackle the impact of the global economic slowdown, damping demand for the safety of the greenback.

The Dollar Index, which tracks the U.S. currency against those of six major trading partners, may decline for a third day after Wen said China’s public spending will more than double this year to 908 billion yuan ($133 billion). In his report today to the National People’s Congress in Beijing, equivalent of a U.S. State of the Union speech, Wen also reiterated an 8 percent growth target for this year.

“This shows that they are quite determined to make sure the economy continues to grow and is positive for risk-taking appetite,” said Lee Wai Tuck, a currency strategist at Forecast Pte in Singapore. “This may be negative for the dollar and the yen as haven currencies.”

Dollar Index

The Dollar Index, which the ICE uses to track the U.S. currency against the euro, yen, pound, Swiss franc, Canadian dollar and Swedish krona, traded at 88.757 from 88.577 yesterday when it reached 89.624, the highest level since April 2006.

Asian stocks rose, with the Nikkei 225 Stock Average adding 2.7 percent and the MSCI Asia Pacific Index of regional shares gaining 2.2 percent. 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, fell 6.6 percent yesterday, the most in more than a week, to 47.56.

In so-called carry trades, investors get funds in a country with low borrowing costs and invest in another with higher rates. The risk is exchange-rate fluctuations can erode those profits. The overnight lending rate in Japan is 0.1 percent, compared with 3.25 percent in Australia and 3.5 percent in New Zealand.