Euro to remain under pressure as debt fears flare up

NEW YORK Fri May 20, 2011 4:25pm EDT

A man is reflected on an electronic board displaying exchange rates in a business district in Tokyo May 16, 2011. REUTERS/Toru Hanai

A man is reflected on an electronic board displaying exchange rates in a business district in Tokyo May 16, 2011.

Credit: Reuters/Toru Hanai

NEW YORK (Reuters) - The euro should remain vulnerable to negative headlines about Greece's debt next week, but will likely trade with a range as investors hesitate selling the single-currency with a key European Central Bank meeting around the corner.

While the euro dropped about 4 percent against the dollar in May, interest rate differentials have largely been working in favor of the currency and it is still up 6 percent year-to-date.

While the single-currency's fragility was made evident on Friday when ratings agency Fitch downgraded Greece and Norway suspended a grant payment to the country, the currency will likely remain range bound over the near-term with the ECB widely expected to communicate plans for another rate hike at its meeting on June 2.

The negative Greece news caused the euro to sink a session low of $1.4139 on trading platform EBS before paring losses on a commodities rebound.

Investors are focused on the key $1.40 level for the euro.

"The market lacks conviction, so any dollar gains we may see next week will not so much be about the dollar but about euro weakness," Marc Chandler, global head of currency strategy Brown Brothers Harriman in New York.

Chandler said the euro will likely trade between $1.4050 and $1.4350 next week.

"The euro should remain in this range because few people will want to sell it ahead of the upcoming ECB meeting."

Spain's upcoming regional election this weekend could impact the euro, however.

"European officials have been successful in establishing a firewall around Spain and insulating it from the crisis in the peripheral. That firewall may be tested shortly," Chandler said.

Spain's Socialist government faces major losses to the center-right opposition Popular Party, and analysts are wary that there could be the potential for unearthing of unknown financial problems.

In late afternoon New York trading, the euro was last at $1.4171, down 1 percent on trading platform EBS, although on the week it was still up 0.7 percent.

The dollar has enjoyed a broad-based rebound recently that has been fueled by a massive unwinding of short-U.S. dollar positions and a general pullback in riskier assets.

The value of the dollar's net short position fell to $20.01 billion in the week ended May 17, from $27.68 billion the week before and down from a two-month high of $35.01 billion on May, according to CFTC and Reuters calculations.

In order for the dollar to make a more sustainable push higher, investors will want to see the Federal Reserve moving closer to more normal monetary policy, according to Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington.

"While additional near-term strength in the dollar is likely, especially if Europe's debt problems take a turn for the worse, its upside will continue to be limited as long as the Fed remains content to leave lending rates as rock-bottom levels."

Traders also said news Hungary has agreed with banks to fix a below-market rate on Swiss franc-denominated mortgages has pressured the euro/Swiss franc pair. Hungary will use an exchange rate of 180 forints per franc, far below the current market rate of 215.84.

So far that 1.24 level has held in the euro/Swiss franc pair, currently down 1.3 percent at 1.2442.

The euro also fell against the yen to trade 0.9 percent lower at 115.74 yen, although it stayed well above a recent two-month low near 113.40 yen.

The dollar recovered earlier falls to trade up against a basket of currencies .DXY, 0.6 percent higher at 75.540, though it stayed below a recent peak of 76.00 struck earlier this week. The dollar was flat against the yen at 81.58 yen.

Next week ushers in a slew of global economic data.

In the U.S., data on durable goods and a second look at first quarter GDP will be a focus of attention.

In Europe, the European Central Bank will be closely watching developments with German HICP inflation and euro area M3 money supply next week.

(Additional reporting by Gertrude-Chavez Dreyfuss, Steven C. Johnson and Nick Olivari)