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Dollar May Fall as ECB Signals Higher Interest Rates (Update2)

*I believe this suddenly increases future odds that there will be a 50 bps rate hike in the U.S.!...

Dollar May Fall as ECB Signals Higher Interest Rates (Update2)

Oct. 10 (Bloomberg) -- The dollar may drop against the euro and yen after the European Central Bank and Bank of Japan indicated they are preparing to raise interest rates, a Bloomberg News survey showed.

Fifty-one percent of the 61 traders, strategists and investors surveyed on Oct. 7 from Sydney to New York advised selling the dollar against the euro, compared with 31 percent that recommended buying the U.S. currency. Fifty-seven percent predicted the dollar would drop versus the yen.

Higher rates in Europe and Japan will erode the yield advantage that lured investors to the dollar, which rose for three straight quarters as the Federal Reserve increased interest rates. Survey participants for the first time in five weeks bet the euro would outperform the dollar after ECB President Jean- Claude Trichet said he's ready to lift rates at ``any time.''

``With the ECB and Bank of Japan coming into the picture, that would argue for the dollar slipping back,'' said Nic Pifer, head of global fixed income at Riversource Investments in Minneapolis, which manages $2.3 billion. ``The Fed continuing to tighten is supportive for the dollar, but it's not the new news.''

The dollar's 0.9 percent decline last week was the first since the week ended Sept. 2, when Hurricane Katrina smashed into the Gulf Coast. The U.S. currency traded at $1.2117 per euro at 12:42 p.m. in Singapore from $1.2129 late in New York on Oct. 7, according to electronic currency-dealing system EBS. The U.S. currency was at 113.76 yen from 113.80. It gained 0.3 percent against the yen last week.

Rate Differences

The dollar's gain against the yen wasn't anticipated by Bloomberg's previous survey, which also showed participants split on the outlook for the dollar versus the euro. The survey has accurately forecast the dollar's direction in 14 of 26 weeks for the euro and 10 of 26 for the yen.

The Fed's benchmark rate is 3.75 percentage points higher than Japan's central bank zero percent target, the widest difference since July 2001. The ECB has kept its rate at 2 percent for more than two years.

Interest rate futures signal investors anticipate the ECB will lift its rate to 2.25 percent as soon as next quarter and Bank of America Corp. predicts higher rates in Japan by April. Traders added to bets on further Fed increases after a Labor Department report on Oct. 7 showed the U.S. economy lost fewer jobs in September than economists predicted.

`Market on Alert'

Concern that record oil prices would slow growth evaporated on mounting evidence Katrina wasn't strong enough to derail the economy's expansion. Kansas City Fed President Thomas Hoenig said last week the effects of the storm may be short-lived and inflation posed a greater threat than a slowdown, bolstering speculation interest-rate increases will continue.

Interest-rate futures traders raised bets the U.S. central bank will boost its benchmark rate to 4.5 percent by Chairman Alan Greenspan's last meeting in January. The Fed's interest-rate target is 1.75 percentage points higher than the ECB's 2 percent benchmark rate, the widest gap since January 2001.

``U.S. rate hikes are in the bag, but the market now feels like the rate differential will be compressed by a move by the ECB,'' said Neil MacKinnon, chief economist at currency hedge fund ECU Group Plc in London, which manages $750 million. Trichet's comments ``put the market on alert for an increase in rates and that will underpin the euro.''

Focus on Fukui

ECU Group's ECU Managed Currency fund was the second-best performing fund in August, according to a survey of 60 funds by Parker Global Strategies LLC published on Sept. 23.

Bank of Japan Governor Toshihiko Fukui said on Oct. 3 that the nation's recovery is ``fully sustainable.'' His comments came less than a week after he indicated the central bank may end its four-year policy of holding borrowing costs near zero, forecasting that the deflation that has been stunting Japan's economy for more than seven years may cease by year-end.

Fukui is likely to make similar comments when he presents the central bank's monthly report on Oct. 12 in Tokyo, some investors said.

``I am slightly bullish on the yen because I expect Fukui to make some hawkish comments on the Japanese economy,'' said Tomoko Fujii, a currency strategist at Bank of America in Tokyo. She said the yen may strengthen to as much as 113 this week.

The dollar's drop against the euro may be limited by speculation the European Central Bank's efforts to rein in inflation to below its 2 percent target will be constrained by sluggish economic growth. The 12-nation region has lagged behind the U.S. for four consecutive years.

ECB Focus

``The trend for the dollar to rise, backed by the prospects of higher rates in the U.S. will remain in place,'' said Keizo Tanaka, manager of the market trading department at Resona Bank Ltd. in Tokyo. ``Trichet's comments on rates in Europe aren't enough to end the stronger dollar trend or to set up a new trend for the euro to strengthen.''

Germany is relying on exports to spur growth after the domestic economy contracted in the first half. The HWWA institute, one of six research organizations that advise the government, last month lowered its growth forecast for this year and next.

At the same time, inflation in the euro region accelerated to 2.5 percent in September, the eighth month the ECB failed to keep price increases below its 2 percent ceiling.

``There might be some kind of disappointment in the market that could damage confidence in the euro,'' said Brian Taylor, chief currency trader at Manufacturers & Traders Trust in Buffalo, New York. ``The ECB is focused on both inflation and growth. They have yet to have a sustained amount of positive data for economic growth.''

                          BUY      SELL      HOLD 
 Euro                       31        19        11 
 Yen                        34        17         8 
 British pound              15        31        11 
 Australian dollar          17        16        25 
 Swiss franc                22        19        16 
 Canadian dollar            10        14        19 
  
 Euro versus yen            14        21         8

To contact the reporter on this story:
Jake Lee in London at [e-mail];


LINK: http://www.bloomberg.com/apps/news?pid=10000100&sid=ayhUI8QsFmgE&refer=germany