* ECB holds rates at 0.75 percent, cuts inflation, growth outlook * ECB President Draghi says wide discussion on rates * Political tension in Italy grows By Wanfeng Zhou NEW YORK, Dec 6 (Reuters) - The euro was headed for its sharpest drop against the dollar in a month on Thursday after comments from the European Central Bank chief and a downgrade to the region's growth and inflation forecasts boosted expectations of an interest rate cut. Political chaos in Italy drove Italian bond yields higher and added to losses in the euro. Silvio Berlusconi's People of Freedom party withdrew its support for Italy's technocrat Prime Minister Mario Monti on Thursday, setting up a conflict that could force an early election. ECB President Mario Draghi, speaking at a news conference after the bank's decision to keep its main interest rate at 0.75 percent, said there was a wide discussion on interest rates but the consensus was to leave the rates unchanged. "That could be the signal that 2013's first ECB monetary decision could include another cut in interest rates," said Neal Gilbert, market strategist at GFT in Grand Rapids, Michigan. "The underlying reason for euro weakness is still there, and the ECB's warnings of continued weakness over the next year could be the catalyst for a continued euro drop." Draghi's comments came as the ECB predicted the euro zone economy would shrink again in 2013 and sharply lowered its growth and inflation forecasts. It also said risks to growth remain on the downside. The bank forecast gross domestic product in a range of falling by 0.9 percent to growing by just 0.3 percent next year, suggesting contraction is far more likely than not. It predicted inflation at 1.1 percent to 2.1 percent next year. "The combination of the ECB's cooler growth and inflation forecasts opened the door to a rate cut in the months ahead," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington. Draghi also said policymakers discussed setting a negative rate on the ECB's deposit facility in an attempt to encourage banks not to hoard cash at the ECB but lend it into the real economy instead. The euro fell as low as $1.2960 on Reuters data and was last down 0.7 percent at $1.2971. At current levels, it was on track for the biggest daily percentage fall since Nov. 2. The euro lost 0.9 percent to 106.79 yen. Italian and Spanish government bond yields rose on tensions in Italy. A disappointing Spanish bond sale on Wednesday also weighed as it revived talk of an official bailout request from the euro zone's fourth-largest economy. "Some analysts are predicting Italy could be contracting by as much as negative 3 percent next year. If that's the case, then they could become another financing crisis for the euro zone," said Boris Schlossberg, managing director of FX Strategy at BK Asset Management in New York. Investors are shifting attention to Friday's closely watched government report on nonfarm payrolls for November. Payrolls likely rose only 93,000 last month after advancing 171,000 job in October, according to a Reuters survey of economists. The unemployment rate is seen holding steady at 7.9 percent. Some analysts said that while the outlook for the euro zone remained bleak, euro losses against the dollar could be limited. "As we expect the (Federal Reserve) to announce a shift to outright Treasury purchases next week, the U.S. dollar should remain soft," said Vassili Serebriakov, currency strategist at BNP Paribas in New York. The Fed holds its December policy meeting next week. BNP forecasts the euro at $1.33 by the end of the year. The dollar slipped 0.2 percent to 82.32 yen, not far from a near eight-month high of 82.82 hit on Nov. 22. Traders expect the yen to remain under pressure on expectations of further monetary easing by the Bank of Japan following an election on Dec. 16. The Australian dollar rose to a 2-1/2-month high of $1.0515, after surprisingly strong Australian jobs data prompted investors to reduce expectations of further policy easing. It was last up 0.3 percent at $1.0490.
Trending On Reuters
Earthquake Strikes Nepal
A powerful earthquake struck Nepal and sent tremors through northern India on Saturday, killing more than 1,000 people, toppling a 19th-century tower in the capital Kathmandu and touching off a deadly avalanche on Mount Everest. Story
RBI chief Rajan calls for formal financing routes for farmers - report Full Article
India to host Afghan leader, seeks to regain ground lost to China, Pakistan Full Article