FOREX-Euro soft on deflation fears ahead of ECB meeting

Mon Feb 3, 2014 4:32am EST

Related Topics

* Euro hits two-month low vs dollar

* Expectations grow of euro zone quantitative easing

* Dollar gains vs yen after recent losses

By Laurence Fletcher

LONDON, Feb 3 (Reuters) - The euro was soft on Monday as investors thought it more likely the European Central Bank would have to ease policy in a radical way to combat slowing inflation, with the bank meeting later this week.

With trading volumes still subdued after Friday's Lunar New Year holiday in Asia, investors are also eyeing a U.S. manufacturing purchasing managers' index on Monday for direction on the strength of the U.S. economy. Non-farm payrolls data on Friday also loom, after last month's low number shocked analysts.

The euro fell as far as $1.3479 in early Monday trade, equaling Friday's low of $1.3479, which was its weakest level since late November. It was last down marginally at $1.3482.

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. It later recovered to 137.63 yen, down marginally on the day.

Investors' nervousness over the euro intensified on Friday after euro zone inflation data showed a surprise drop to 0.7 percent year-on-year in January, compared with analysts' expectations of a 0.9 percent rise.

With interest rates already at a record low of 0.25 percent, analysts increasingly expect the ECB to start buying sovereign bonds to loosen monetary conditions.

"What really matters is deflation," said Hans Redeker, head of global currency strategy at Morgan Stanley. "The euro is going to find it very difficult to hold its value.

"I think that with a ... fall in inflation and the development of deflation expectations the only credible instrument is outright QE (quantitative easing). It's not the best tool, but there's no other tool available."

The euro dipped 0.3 percent against the Swedish crown to 8.7993 crowns after the Swedish manufacturing purchasing managers' index beat forecasts.

Global markets have been affected in recent days by a sharp sell-off in emerging markets, which has pushed up the value of the yen, traditionally seen as a safe haven.

The U.S. PMI and payrolls data on Friday could signal the U.S. economy is growing fast enough for the Federal Reserve to keep cutting back its bond-buying programme - a move that encourages investors to pull back money from emerging markets to U.S. bonds.

"If the PMI is relatively strong, the possibility that will lead to a further eruption (in emerging markets) is quite high," added Morgan Stanley's Redeker, who expects dollar-yen to fall to 98 in the coming four weeks.

Against the yen, the dollar gained 0.2 percent at 102.19 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.

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