FOREX-Euro struggles as expectations of looser ECB policy grow

Anirban Nag
Friday, 1 Nov 2013 | 7:59 AM ET

* Euro falls for fifth day as inflation slows

* UBS expects ECB rate cut next week

* Euro/dollar implied vols jump on renewed spot weakness

LONDON, Nov 1 (Reuters) - The euro fell to a two-week low against the dollar on Friday, extending losses to a fifth day as slowing euro zone inflation led some in the market to forecast a near-term European Central Bank rate cut. A cut would hurt the euro's rate advantage over other major currencies. The euro's weakness was broad-based; it hit a near three-week low against the yen and a two-week trough against sterling. Its losses triggered fresh demand to hedge against further weakness with one-month euro/dollar implied volatilities hitting their highest in three weeks at 7.2 percent. In higher volumes than of late, the euro fell to $1.3508 in European trade, its lowest since Oct. 16. It was last down 0.4 percent at $1.3530, having fallen 1.1 percent on Thursday. The losses left it on track for its worst weekly performance since early February. The euro's fall accelerated after data on Thursday showed euro zone inflation fell to a four-year low of 0.7 percent in October, way under the ECB's target of just below 2 percent. "In light of those inflation numbers, we have changed our call and are now expecting the ECB to cut its main refinance rate at next week's meeting," said Geoffrey Yu, currency strategist at UBS. "While some in the market have priced that in, quite a few haven't. We recommend investors to hold short positions in the euro and add to those positions after the ECB meeting." A depressed euro zone labour market, with unemployment still at record highs in September, will give the ECB another reason to consider easing policy at next Thursday's meeting. Thursday's jobs report included revisions to previous months' data, bolstering a widely-held view that an elevated currency is the last thing euro zone policymakers want. "Our economists now forecast a rate cut in December," said analysts at BNP Paribas. "Given that the market has under-priced this risk, we think that there is substantial scope for the euro to weaken in the next few weeks." Options traders cited renewed demand for euro puts or bets the currency will fall. One-month risk reversals - a measure of relative demand for options on a currency rising or falling - were at 0.7 vols in favour of euro puts. Just a week ago, there was a slight bias for euro calls - or bets it would gain.

RENEWED PRESSURE Renewed pressure on the euro saw the dollar index rise to a two-week high of 80.547, pulling further away from a nine-month trough of 78.998 plumbed a week earlier. The dollar was helped by Thursday's strong Chicago business activity survey, which fuelled speculation the national ISM survey of manufacturing, due later on Friday, could also deliver a positive surprise. The upbeat data revived speculation the Federal Reserve may scale back stimulus at its December meeting, though many still tip March as the likeliest window for a move.