Euro could fall further ahead of ECB policy meeting

A picture illustration shows U.S. one dollar bank notes and a one Euro coin, taken in Warsaw January 26, 2011. Picture taken January 26.

NEW YORK (Reuters) - The euro may weaken next week ahead of a European Central Bank meeting that may signal its intention to ease due to the region's deteriorating economic outlook.

The dollar will likewise be in focus, with a Federal Reserve monetary policy meeting next week that is expected to hold U.S. interest rates unchanged but may acknowledge the recent improvement in U.S. economic data.

For some strategists, a suddenly revitalized U.S. economy has diminished the prospect of further "quantitative easing" and should provide some support for the greenback.

"I think for the euro the most important thing is if the ECB cuts rates," said Jens Nordvig, global head of G10 currency strategy at Nomura Securities in New York.

"The level of the PMI (purchasing managers' indexes) suggests Europe is in recession already. And it's just a matter of time as to when the ECB is going to reduce rates to at least 1 percent."

According to a Reuters poll, there is an outside chance of a rate cut next week.

In late Friday afternoon trading, the euro was last down 0.2 percent at $1.41603 after scaling seven-week peaks versus the dollar on Thursday. It gained 2.1 percent on Thursday, nearly the entire weekly gain for the euro against the dollar.

Europe's common currency slipped on Friday after the auction yield on new 10-year Italian government debt hit a euro lifetime high. It was the first euro zone bond supply since European leaders struck a deal on anti-crisis measures this week.

The deal struck on Wednesday included an agreement that private banks and insurers accept 50 percent losses on their Greek debt holdings, a leveraging of the euro zone bailout fund and recapitalization of banks.

DOUBTS ON EU SUMMIT DEAL

Analysts said the euro remains vulnerable as the euro zone still needs to find the money to expand its bailout fund and doubts linger as to whether the fund's increased size of around 1 trillion euros would be enough to staunch the crisis.

"Most of what the package is doing is trying to sort out the symptoms of the problem that we see in Europe," said Ken Dickson, investment director for currencies at Standard Life Investments in Edinburgh, with assets under management of about $252 billion.

"But the underlying problems of high funding costs in countries with low nominal growth rates, combined with pretty high levels of debt, make the situation still quite difficult for the euroland."

Resistance in the euro is around $1.4255, the 61.8 percent retracement of the May to September decline.

Analysts said much of this month's 5.8 percent rally in the euro against the dollar was driven by a squeeze of short bets and many speculators would be reluctant to start building bets against the euro ahead of the Fed meeting next week.

Standard's Dickson however, believes the short squeeze higher on the euro is almost done since the currency has rallied quite a bit from its low in September.

"The combination of what we think is the need for easier monetary policy in Europe, plus a continuation of the improvement in U.S. data suggests to us that for the remainder of this year, the euro will weaken again versus the dollar," said Dickson, who forecasts the euro at $1.30 by year-end.

The litmus test on whether the U.S. economy is indeed improving comes next Friday with October's jobs data.

A reading below 100,000 -- a Reuters poll showed a forecast of 95,000 jobs created -- points to a probable uptick in the unemployment rate, CIBC Markets said, making the labor sector still a major roadblock to a sustainable recovery.

Another factor that is likely to matter for the euro next week is a summit of finance ministers and central bankers of the Group of 20 countries. This week's EU meeting produced an agreement that lacked substantive details and analysts said the G20 needs to fill in some of the gaps to sustain market optimism.

In other currency pairs, the dollar was down 0.3 percent against the yen at 75.760 yen but off the all-time low of 75.661 hit on trading platform EBS on Thursday.

That prompted Japanese Finance Minister Jun Azumi to repeat a warning that he would take firm steps against the yen's rise as needed and kept traders on alert for any sign of intervention from the Japanese authorities.

(Additional reporting by Nick Olivari; Editing Dan Grebler)