Euro plunges on ECB Draghi's currency comment, economic risk

NEW YORK Fri Feb 8, 2013 3:17am IST

NEW YORK (Reuters) - The euro slid against the dollar and yen on Thursday after European Central Bank President Mario Draghi voiced concerns about the currency's recent rise and cited economic risks, raising the odds of a rate cut down the road.

The euro zone currency slipped against the dollar and yen for a second straight session as Draghi voiced concerns about the impact of the currency's exchange rate on the economy at a news conference after the ECB held its benchmark interest rate steady at 0.75 percent.

He said that, while economic activity in the euro area should recover gradually in 2013, there are more negative risks than positive ones. Draghi also said the euro's exchange rate was near its long-term average, going further than many analysts had expected.

"The exchange rate is not a policy target, but it is important for growth and price stability and we certainly want to see whether the appreciation is sustained," Draghi said.

"Draghi's comments were neutral to modestly dovish, which means a rate cut is still on the table," said Ben Emons, senior vice president/global portfolio manager, at Newport Beach, California-based PIMCO, which had $2 trillion in assets as of December 31.

"If the euro puts too much pressure on CPI (consumer price index), the ECB may have look at more liquidity operations or a potential rate cut to offset the downward pressure on prices," he said.

The euro last traded at $1.3398, down 0.9 percent on the day, after earlier sliding to a trough of $1.3369, the lowest since January 25. At the session low, it was the biggest one-day percentage drop since June.

"Interest rate differentials are the main driver of the euro's move today," Emons added. "The ECB is not in a position to change policy right now due to fragmentation, with financial market conditions looking very good, but credit conditions in some European economies not."

Emons, who oversees $70 billion in global assets, said the euro will likely remained contained to a range of $1.30 to $1.40 for the next three to six months.

"I am not overly bullish on the euro, but I also do not see much scope for a significant change in either direction," he said.

Against the yen, the euro last traded at 125.38 yen, down 1 percent, but above the session low of 124.48 yen.

Despite Thursday's declines, the euro is up about 1.6 against the greenback so far this year and around 9.6 percent versus the yen.

The February 1 appreciation of the euro to its highest against the dollar since November 2011 prompted French President Francois Hollande to recently call for an exchange rate policy to protect the currency from "irrational movements."

A persistently strong euro could derail exports and threaten the euro zone's nascent economic recovery. German officials have said the shared currency is not over-valued.

OVERSHOOT

But some analysts cautioned that the selloff in the euro might be too far, too fast and only short term.

Christopher Vecchio, currency analyst at DailyFX in New York, noted Draghi also said the high euro is a sign of confidence in the region.

"Any further euro losses should be limited beyond the initial knee jerk that we've seen thus far today," said Vecchio.

A Spanish bond auction on Thursday drew healthy demand, but a slight rise in yields on the short-dated paper limited gains in the euro.

While the yen was up against the dollar and euro, investors believe its trajectory remains downward on forecasts the next leader of the Bank of Japan will usher in more forceful action.

The dollar last traded at 93.58 yen, down 0.1 percent on the day, according to Reuters data. It reached 94.06 on Wednesday, the highest since May 2010.

"The yen has some scope to depreciate further, perhaps to 95-98," said PIMCO's Emons.

"I do not see 100 yen, but a lot will hinge on who the next Bank of Japan governor is and whether he is going to signal more aggressive monetary policy action," he said.

Elsewhere, the Bank of England said it was keeping interest rates on hold at 0.5 percent and its quantitative easing total unchanged at 375 billion pounds.

Meanwhile, Ireland clinched a long-awaited deal to ease the burden of its bank debts, sending its borrowing costs falling to pre-crisis levels and bolstering its chances of ending its reliance on EU-IMF loans this year.

The yield on Irish benchmark 2020 bonds fell as low as 3.955 percent, the lowest seen in an equivalent Irish benchmark bond since early 2007, before the subprime crisis started, according to Reuters data.

(Additional reporting by Nick Olivari. Editing by Andre Grenon)

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