FOREX-Euro edges higher, vulnerable to ECB Draghi's comments

Thu Feb 7, 2013 7:06am EST

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* Markets cautious that euro strength may concern ECB

* Could dip further before ECB decision at 1245 GMT

* Most feel Draghi won't explicitly mention euro moves

* Broader trend for further euro gains intact

By Anooja Debnath

LONDON, Feb 7 (Reuters) - The euro rose on Thursday as Asian sovereign investors and macro funds bought, but most investors refrained from aggressively adding bets on the currency strengthening before a European Central Bank meeting.

While the ECB is widely expected to keep interest rates on hold when it announces its decision at 1245 GMT, investors will watch for any comments from its President Mario Draghi at his 1330 GMT news conference about how the currency's strength might affect the fragile euro zone economy.

While the chances of Draghi voicing any concern about the currency are slim, given the trade-weighted euro has risen a modest 3 percent since early last month, any hint of discomfort could drag the currency sharply lower.

On the other hand, if he sounds unconcerned about the euro's rise and reiterates the G20's commitment to market-determined exchange rates, the euro is likely to bounce and could retest recent highs.

"The key question Draghi will be asked is about currency wars," said Neil Mellor, currency strategist at Bank of New York Mellon.

"He will likely say currency moves should be set by the markets, leading most to assume that the ECB is not prepared to do anything and the euro will probably go a little higher at the end of the meeting."

The euro was up 0.3 percent at $1.3563. It could retest yesterday's high of $1.3597 and move towards the $1.38-$1.40 region over the next few weeks, strategists said. The euro hit a 15-month high of $1.3711 on Feb. 1.

If Draghi did comment that the higher euro was likely to hurt the euro zone economy, the currency could make a swift move down to its Jan. 29 low of around $1.3414 and possibly lower, they said.

The euro was up 0.6 percent at 127.38 yen, not far from its 34-month high of 127.71 yen hit on Wednesday. Traders cited stop loss sell orders at 127.50 yen and 127.70-75 yen, which could cap its gains, for now.

The euro has risen more than 2 percent against the greenback so far this year and over 10 percent versus the yen. This has triggered strong protests from some European politicians.

But while the French have raised concerns a strong euro could derail exports and threaten a nascent euro zone recovery the Germans have said the shared currency is not over-valued.

Draghi sounded optimistic about a euro zone recovery last month, helping set the stage for a sharp euro rally. But this is unlikely to be enough to prompt the ECB chief to explicitly talk about the euro.

"Previous ECB President Jean-Claude Trichet had used the term "brutal" to describe euro gains," said analysts at Morgan Stanley in a note. "However, we do not believe that the current euro rise is yet at the stage where it is impacting the ECB's monetary stability mandate, requiring verbal intervention."

POTENTIAL RISKS

Other potential risks to the euro would come from any comments Draghi makes on an Italian banking scandal and the recent rise in money market interest rates after some banks repaid loans from the ECB early.

"What Draghi might do is address concerns about declining liquidity in the euro zone and assure markets there is plenty of liquidity and it is too soon to tighten monetary conditions," said Elisabet Kopelman, FX and FI strategist at SEB.

A Spanish bond auction earlier on Thursday drew healthy demand but a slight rise yields on the short-dated paper limited gains in the euro.

The dollar was up 0.3 percent against the yen at 93.87 yen , putting it on course to test its 33-month peak around 94.075 yen hit on Wednesday. U.S. speculative accounts were still actively buying the dollar on dips, with stop-loss orders said to be placed at 93.20 yen and just below 93 yen.

Sterling rose on Thursday after incoming Bank of England governor Mark Carney showed little bias towards immediate looser monetary policy, wrong footing many investors who had expected him to be more dovish.

The pound rose 0.3 percent to $1.5708 as investors who had bet on hints of more aggressive easing measures from Carney, who takes the helm in July, covered their short positions.

Traders cited buying by an Asian central bank, before sterling ran into offers around the $1.5775-90.

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