Euro on track for best week since July; Fed awaited

NEW YORK Fri Sep 16, 2011 4:43pm EDT

U.S. dollar, euro and Swiss franc bank notes are seen in a bank in Budapest August 8, 2011.REUTERS/Bernadett Szabo

U.S. dollar, euro and Swiss franc bank notes are seen in a bank in Budapest August 8, 2011.

Credit: Reuters/Bernadett Szabo

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NEW YORK (Reuters) - The euro headed for its best week in eight against the dollar on Friday but the gains appeared to be running out of steam as investors deemed policymakers' latest action insufficient to solve Europe's debt crisis.

Gains in the euro were fueled by the European Central Bank's announcement on Thursday of joint action with other central banks to offer three-month dollar loans to banks in order to ease pressure in the money market. But the euro's rally faded on Friday as traders refocused on the risk of an eventual debt default by Greece.

Attention will shift to the United States early next week, with the Federal Reserve set to hold its September policy meeting on Tuesday and Wednesday. Many investors expect the U.S. central bank's Federal Open Market Committee to take some form of intervention in the bond market to stimulate the sluggish economy.

With Europe's debt troubles lingering and the United States unlikely to announce a third round of quantitative easing, analysts see the euro remaining under pressure, with any dollar weakness likely be used as a buying opportunity.

"I'm still bearish on the currency. The only risk I see to that outlook would be the FOMC come out with a surprise," said Jessica Hoversen, FX analyst at MF Global in New York.

The most likely scenario for the Fed next week is to adopt "Operation Twist," in which the Fed would buy longer-dated Treasury bonds and sell shorter-dated ones to lower long-term rates without expanding the balance sheet.

Such a move has already been priced in and therefore should have little impact on the dollar, analysts say. By contrast, in quantitative easing, the Fed buys government securities for its balance sheet, which would increase dollar liquidity and encourage risk appetite, leading to currency weakness.

The euro was last down 0.6 percent at $1.37860, off a one-week peak of $1.39370 hit on Thursday but held above a seven-month trough below $1.35 plumbed on Monday. The euro has gained around 1.6 percent this week, its best weekly performance since the week of July 24.

Currency speculators boosted bets against the euro in the latest week, data from the Commodity Futures Trading Commission showed on Friday. They also turned long on the U.S. dollar for the first time since July 2010, with a net long position of $1.77 billion, compared with a net short position of $3.94 billion a week earlier.

FADING RALLIES

Disappointment over a meeting of European Union finance ministers that ends on Saturday could also weigh on the euro.

U.S. Treasury Secretary Timothy Geithner urged EU finance ministers Friday to leverage their bailout fund to better tackle the debt crisis and to start speaking with one voice, but his proposal met resistance.

Less than 75 percent of private sector creditors have signaled they will take part in a scheme to buy back Greek debt, far less than the 90 percent target set by Greece, a shortfall that could jeopardize the euro zone's second bailout package for Athens.

A Reuters poll showed Greece will likely default on its sovereign debt within a year after it exhausts the patience of its euro zone partners, but there is only a one-in-five chance it will leave the 17-nation euro zone.

"In this environment, we continue to recommend being defensively positioned and suggest fading rallies in the euro and risk currencies more generally," said Sara Yates, currency strategist at Barclays Capital in London..

"However, with the market short euro/dollar, should we be surprised by political progress, euro/dollar could squeeze higher. For this reason, we prefer to express our bearish view by buying a euro/dollar put spread."

The dollar rose 0.1 percent to 76.83 yen. The threat of Japanese intervention has kept dollar/yen in a tight range and above its record low around 75.94. On the week, the dollar lost 0.8 percent, the biggest weekly drop in a month.

(Additional reporting by Gertrude Chavez-Dreyfuss; Editing by Leslie Adler)

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