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Monday March 31, 2008 - 11:44:12 GMT
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FOREX NEWS-Euro zone inflation dims rate cut view, boosts euro

Mon Mar 31, 2008 7:36am EDT

(Updates prices, adds quote)

By Toni Vorobyova

LONDON, March 31 (Reuters) - The euro held firm versus the dollar on Monday after higher-than-forecast euro zone price data reinforced expectations that the inflation-focused European Central Bank will not start cutting rates soon.

Annual euro zone inflation jumped to a record high of 3.5 percent in March, out-stripping the 3.3 percent consensus.

"It's higher than expected and it will do nothing to calm down the ECB's concerns, and until we get some evidence that the much-feared second round effects aren't materialising, then the ECB is going to stay hawkish," said Adam Cole, global head of FX currency strategy at RBC Capital Markets.

"I think (the euro) will continue to grind higher, back up towards the historic high, and I think we will test $1.60 before too long."

The euro rose as high $1.5834 after the data -- around 2/3 of a cent short of the record highs set two weeks ago <EUR=> -- before retreating a little to around $1.5807 by 1113 GMT.

In the United States, the Federal Reserve, more concerned than the ECB about slowing growth, has slashed rates by 300 basis points since September and is seen moving again next month FEDWATCH.

The contrasting interest rate and growth paths have pushed the euro 8 percent higher versus the dollar since the start of the year, on track for its best quarter since late 2004.

The single European currency scaled all-time peaks at 79.67 pence <EURGBP=>, with sterling depressed by soft housing and service sector data.

Speaking just before the euro zone data was released, ECB Governing Council member Erkki Liikanen said there are upside pressures to inflation in the euro zone, echoing the tone of recent comments from fellow policymakers.

Money markets are now pricing in an around 90 percent chance of a 25 basis point ECB rate cut from the current 4 percent by year-end -- compared with expectations of nearly 75 basis points of easing a month ago FEIZ8.


Higher-yielding currencies like the Australian <AUD=> and New Zealand <NZD=> dollars tracked equity markets lower, indicating that nervousness about the health of the global economy remains at the forefront of investors' minds.

Adding to a risk averse mood were end-quarter tensions in the short-term money markets, which have persisted despite liquidity pumping measures from major central banks.

Investors shied away further from relatively risky carry trades in which low-yielding currencies like the yen are used to fund investment in high-yielders such as the Aussie.

The dollar has also taken on low-yielding status as the Fed's easing has taken the policy rate to 2.25 percent -- the second lowest among major economies after Japan [INT/RATE].

The yen, however, failed to benefit from the increased risk aversion, as fiscal year-end activity from Japanese investors and corporates kept the currency under pressure, traders said.

The dollar rose half a percent at 99.65 yen <JPY=>, while the euro edged up to 157.52 yen <EURJPY=>.

Monday is relatively light on the U.S. data front, so investors are looking ahead to the Institute for Supply Management's March manufacturing and service sector surveys on Tuesday and Thursday respectively, followed by the non-farm payrolls report on Friday.

"A rise in people filing for unemployment claims in March, a worsening in the forward-looking indicators of activity and a drop in household employment expectations mean a 3rd consecutive contraction in non-farm payrolls is highly probable," Lloyds TSB Corpoates & Markets said in a research note.

(Editing by Gerrard Raven)

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