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Euro Gains Ahead of Expected ECB Inaction

Monday, 7 Jan 2013 | 5:19 PM ET
Boomberg | Getty Images

The euro gained for a second straight session against the dollar on Monday, benefiting from technical factors as well as expectations that the European Central Bank will refrain from cutting interest rates at its meeting later this week.

The U.S. currency, meanwhile, retreated from a 2-1/2 year high against the Japanese yen as a robust appreciation over weeks had investors opting to book profits despite forecasts of further Bank of Japan stimulus later in the month.

With U.S. economic data scant this week, currency trading will likely be driven by the ECB's meeting on Thursday, comments from an array of Federal Reserve speakers and sentiment in other asset classes, such as stocks.

"Euro/dollar is being driven by expectations that the Fed will maintain an easy monetary policy stance, which drives the currency pair higher," said Sebastien Galy, forex strategist at Societe Generale in New York.

"Bouts of risk aversion are more likely to hit yen crosses via sentiment, given how much they have moved in the past weeks," he said.

Minutes from December's Fed meeting released last week raised expectations that the central bank could end its bond-buying program, called quantitative easing, this year, but a lackluster non-farm payrolls report last Friday has some expecting the U.S. central bank to maintain the status quo.

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The euro last traded up 0.1 percent against the dollar to $1.313, well above last week's three-week low of $1.2997. Trade was volatile, with the session low at $1.3016 and the peak at $1.3119.

The euro's move higher also gained strength from headlines indicating that Silvio Berlusconi will not stand as candidate for prime minister in next month's Italian election under the terms of a coalition deal with the Northern League. .

George Davis, chief technical analyst at RBC Capital Markets in Toronto, said euro/dollar last Thursday posted a bearish trend reversal below the $1.3100.

"I'm not sure if this is due to the debt ceiling debate at this juncture, as many seem to think that this will heat up and get messy in February and March," he said. "However, if this is the case and it upsets the equity markets, then the resulting 'risk off' environment would be one that is positive for the dollar."

"As such, I would keep an eye on this theme over the next 2-4 weeks," he said.

Trade should be increasingly volatile in the weeks ahead, with heated U.S. political debates on raising the government's borrowing limit, or debt ceiling, and sequestered spending cuts that are to take place in early March likely to benefit the dollar due to its status as a safe haven.

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Analysts cautioned the euro was more likely to remain under pressure as markets refocus on the euro zone's bleak economic landscape and ECB meetings. Any indication of monetary stimulus or comments on economic weakness could push it lower.

"While the Bank indicated its willingness to lower interest rates this year, we do not anticipate a rate cut at this week's meeting as price pressures have increased, with core inflation picking up slightly," said Eric Viloria, senior currency strategist at Forex.com. "As economic activity continues to contract, we think that the ECB will eventually lower rates in the coming months."

Investors will also look at Spanish and Italian bond auctions toward the end of the week. If the sales receive solid demand the euro could gain against the dollar.

Expectations of aggressive monetary easing by the Bank of Japan has caused the dollar to rally more than 8 percent versus the yen since early December. The BOJ meets on Jan. 21-22.

Audrey Childe-Freeman, head of foreign exchange strategy at BMO Capital Markets in London, said there was a risk the BOJ's actions might fall short of market forecasts, leading the dollar to weaken.

"There is a risk that markets got a little bit carried away and that we don't see as much as we were hoping for (from the BOJ) and we see a pullback in dollar/yen."

Traders also said the yen found some support on worries that Japanese mobile operator Softbank's deal to buy 70 percent of U.S. carrier Sprint Nextel could run into complications.

The euro was last down 0.1 percent to 115.12 yen, well below last week's 18-month high of 115.99 yen.

Against the yen, the dollar was down 0.4 percent at 87.78 yen, off Friday's peak of 88.40 yen, which was its strongest since July 2010.

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