FOREX-Euro weak near 3-week lows as ECB tries to tame strength

Wed Mar 26, 2014 7:43am EDT

Related Topics

* Euro seen trading between $1.3750 to $1.3880 range

* ECB's Weidmann hints at negative rates, QE

* Aussie trades near 4-month high on China stimulus hopes (Adds details)

By Anirban Nag

LONDON, March 26 (Reuters) - The euro fell on Wednesday, with investors wary after European Central Bank officials ramped up efforts to talk down the currency, with arguably its most hawkish member hinting at a radical softening of monetary policy.

The single currency hit a three-week low on Tuesday after ECB governing council member and Bundesbank chief Jens Weidmann said negative interest rates were an option to temper euro strength. He added that quantitative easing was not out of the question to combat deflation.

The euro, which had reached a 2-1/2-year peak against the dollar in mid-March on fading expectations of more ECB easing, was trading just above those three-week lows on Wednesday.

The ECB holds a policy meeting next week but before that traders will await euro zone "flash" inflation data on Monday. Another drop in price pressures could bolster expectations that the ECB may have to act soon.

The euro recovered slightly on Tuesday after Weidmann later said current levels does not call for monetary policy action. Traders said comments by ECB President Mario Draghi, who said the central bank does not see a key symptom of deflation in consumer spending traits, also helped.

Nevertheless, the fact that the Bundesbank was open to buying assets from banks to fight deflation marked an unprecedented softening of the German central bank's strict stance on quantitative easing. That was enough to keep investors away from the euro for now.

The euro was trading lower for its second straight day at $1.3800, not far from the three-week trough of $1.3749 hit on Tuesday. It was also lower against the yen at 141.25 .

"The ECB will be dogmatic about trying to talk down the euro. But unless these words are followed up by action we will not see the euro falling much," said Jeremy Stretch, head of currency strategy at CIBC World Markets.

"The euro has good support around $1.3750, while many will look to sell it at $1.3880 (the high struck earlier this week)."

A growing number of officials have stepped up their rhetoric against a firmer euro as it lowers imported inflation and keeps the risk of deflation alive in the euro zone.

ECB Governing Council member Erkki Liikanen said on Monday the bank was keeping a close eye on the euro to see how the exchange rate affected inflation, while European Commission vice-president for industry Antonio Tajani said on Tuesday that at $1.40 the euro was too strong.

Slovakia's central bank governor, Jozef Makuch, who also sits on the ECB board, said the currency should weaken by the end of the year.

DOLLAR CLIMBS

With the euro falling, the U.S. dollar index, which measures the dollar against six major currencies, was up 0.15 percent at 80.051.

Analysts said as diverging monetary policy outlooks become a dominant theme in currency markets, the dollar index could outperform in the second quarter. The U.S. two-year bond yield premium over Germany hit a 15-month high on Wednesday.

Westpac's Richard Franulovich said in a note that the dollar index could rise towards 82 in the second quarter.

"Data momentum appears to be tentatively shifting back in the dollar's favour, at least against the majors, euro/dollar valuation vis-a-vis interest rate differentials is hitting up against unsustainable extremes," it said.

Against the yen, the dollar was firmer at 102.35. The yen has been hemmed in a tight range between 102.01 and 102.65, with traders attributing its inertia to dwindling participation from Japanese investors, many of whom may have closed their books before the end of the Japanese fiscal year this month.

The Australian dollar traded at $0.9217, a four-month high, underpinned by speculation that China will unveil stimulus measures to re-energise its slowing economy. The Aussie is used as a proxy for exposure to growth cycles in China, Australia's key export market. (Editing by Hugh Lawson and Pravin Char)

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