December 18, 2012 / 2:50 PM / in 5 years

FOREX-Euro edges higher vs dollar on US fiscal cliff optimism

* Euro near 7-1/2-month peak vs dollar
    * Scope for year-end demand to test March high near $1.34
    * Yen vulnerable to easing expectations

    By Gertrude Chavez-Dreyfuss
    NEW YORK, Dec 18 (Reuters) - The euro hovered near a
7-1/2-month high against the dollar on Tuesday on signs of
progress in U.S. budget talks and generally improving investor
sentiment on euro zone assets.
    Market players sold the safe-haven dollar on optimism U.S.
policymakers can reach a deal to avoid the so-called "fiscal
cliff," a combination of tax hikes and spending cuts that risks
tipping the world's largest economy into recession.
    According to a source, President Barack Obama was open to
tax rate increases beginning at incomes above $400,000 instead
of his previous proposal of $250,000. 
    "There is some relief that budget negotiations in the U.S.
appear to be progressing," said Camilla Sutton, chief currency
strategist at Scotia Capital in Toronto. 
    "The market views progress as positive. Most expect that the
U.S. fiscal drag will equate to between 1 and 2 percentage
points off the 2013 GDP, therefore avoiding the most severe
    The improvement in market sentiment lifted the euro and also
boosted demand for European shares while pushing Spanish and
Italian bond yields lower.  
    Some strategists said year-end investment flows could help
the euro extend its gains to test the late-March high just below
$1.34, although concerns about the euro zone's weak growth
outlook may leave it vulnerable to selling in the new year.
    The euro was last up 0.1 percent on the day at
$1.31808, near a 7-1/2 month high of $1.3191 hit on Monday. The
dollar index slipped to a two-month low of 79.606.
    If U.S. policymakers do reach a compromise before steep tax
hikes and spending cuts kick in early next year, strategists
said currencies that tend to gain on a better global growth
outlook - like the euro and Australian dollar - should benefit. 
    The Swedish crown rose against the euro to
8.7080 per euro after the Riksbank cut its repo rate by 25 basis
points as expected but said rates would remain on hold for some
time. The outlook wrongfooted some investors who had positioned
for a hint of further cuts in future. 
    The euro was last down 0.4 percent at 8.7279 crowns.
    The yen slipped against the euro, with the single currency
rising 0.2 percent on the day to 110.66 yen, within
sight of a nine-month high of 111.30 yen hit on Monday.
    The Japanese currency tumbled after the Liberal Democratic
Party surged back to power in an election on Sunday, fuelling
expectations the new government will drive the Bank of Japan
towards more aggressive monetary easing.    
    The dollar was up 0.1 percent at 83.98 yen, having
hit a high of 84.48 yen on Monday, its strongest level since
April 2011. Traders cited option barriers at 84.50 yen with
stop-loss buy orders above that level.
    "We are in a situation where we will see the government tell
the central bank what to do. Such a politicised situation is
never good for a currency, and the yen will weaken," said Peter
Kinsella, currency strategist at Commerzbank.
    "Apart from the politics, the economic data from Japan has
not been good. This should see quite aggressive easing from the
BOJ. We are forecasting 90 yen over the coming year."
    Some analysts said there was scope for the dollar to come
under pressure and the yen to edge higher in the near term if
the BoJ disappoints those expecting more aggressive monetary
easing after a two-day policy meeting ends on Thursday.
    Speculators have sold the yen on expectations the BoJ could
adopt a more aggressive asset buying programme. But sources
familiar with the BOJ's thinking have said the most likely
option is for the central bank to increase its asset-buying and
lending programme, currently at 91 trillion yen, by another 5-10
trillion yen. 
    That would fall short of expectations and could lead to some
of the large short yen positions being cut.
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