FOREX-Euro wallows near 10-week low on deflation fears

Sun Feb 2, 2014 11:41pm EST

* Easing euro zone inflation rekindles deflation worries

* Some see ECB cutting rates as soon as this week

* Emerging market nerves highlight risk, support yen

* Market looks to U.S. ISM data for more sign of robustness

By Hideyuki Sano

TOKYO, Feb 3 (Reuters) - The euro licked its wounds near a 10-week low against the dollar on Monday after soft euro zone inflation data rekindled speculation the European Central Bank may ease policy to stave off deflation.

Worries about capital flight from emerging economies also kept investors at arms length from risk assets, underpinning the yen over growth-sensitive, high-yielding currencies.

The euro traded at $1.3489 in early Monday trade, not far from Friday's low of $1.3479, which was its lowest level since late November.

Against the yen, the common currency hit a two-month low of 137.38 yen, facing the risk of settling below its 100-day moving average, now at 137.54, which some chartists could regard as a major bearish signal.

The latest catalyst for the euro's fall was euro zone inflation data on Friday, which showed a surprise easing to 0.7 percent year-on-year in January, matching a four-year low touched in October.

Analysts had expected a rise to 0.9 percent from 0.8 percent in December.

Given that the ECB surprised markets by cutting rates in November, a week after the same inflation data showed a 0.7 percent reading, speculation is rife that the ECB could consider another monetary easing as soon as at its policy meeting on Thursday.

"We expect the euro zone inflation to slow further next month to 0.6 percent and to stay under one percent in March. We think the chance of rate cuts on Thursday is rising," said Shin Kadota, chief Japan FX strategist at Barclays.

U.S. DATA

By contrast, U.S. economic data on consumption was fairly robust, reinforcing views the world's biggest economy can weather the emerging markets turmoil, enabling the Federal Reserve to keep reducing its stimulus.

That helped keep the dollar index near a two-month high set late last month. The index of the dollar's value against six other major currencies stood at 81.271, a stone's throw away from 81.388 hit on Jan. 21.

"The strength of U.S. data is outstanding. U.S. bonds are clearly being bought as a safe haven now," said a trader at a Japanese bank.

The dollar could gain more footing if the Institute for Supply Management's closely watched data due at 1500 GMT points to solid growth in U.S. manufacturing.

Against the yen, the dollar gained 0.3 percent to 102.34 yen, as Japanese importers bought the dollar on dips after the yen's gains on concerns about emerging markets.

Still, the U.S. currency stood not far from an eight-week low of 101.77 yen hit last Monday as investors remained wary of emerging economies.

Since late last month, the prospect of a reduction in U.S. monetary stimulus and slower growth in China have raised fear of capital flight in some emerging economies that rely on foreign capital.

Although many of these currencies, including the Turkish lira and South African rand, posted rebounds late last week, investors are not convinced if the worst is over.

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