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Wednesday December 31, 2008 - 01:21:42 GMT
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FOREX NEWS-Euro best of a bad bunch as rates diverge

Tue Dec 30, 2008 6:52pm EST

SYDNEY, Dec 31 (Reuters) - The euro was gaining ground in Asia on Wednesday as tumbling U.S. yields undermined the dollar, while a truly dire outlook for the UK economy kept sterling pinned near record lows.

Dealers said the euro was proving the best of a bad bunch as the relatively staid pace of easing by the European Central Bank contrasted with the dramatic pace of rate cutting by the Federal Reserve and Bank of England.

"All the major countries have awful economic fundamentals, but right now the euro offers the best pure rate return," said a trader at a local bank in Sydney, noting U.S. yields had all but dropped off a cliff in recent weeks.

"The dollar has the added problem that the Fed is printing loads of them to rescue the economy," he added. "It's a case of more supply than demand at the moment."

The euro edged up to $1.4115 <EUR=> in Asian trade, from $1.4072 late on New York on Tuesday, though trading was very thin with Tokyo on holiday and many investors away for the New Year break. Against a basket of currencies, the dollar was down almost 1 percent .DXY at 80.627.

The euro was also holding firm at 97.75 pence <EURGBP=D4>, having touched a high of 98.05 on Tuesday, and seemed set on reaching parity for the first time since its launch in 1999. The single currency has climbed around 33 percent against sterling so far this year as a slump in the UK economy led the BoE to cut rates from 5.5 percent to just 2.0 percent.

The Fed has been even more aggressive, slashing its funds rate to a record-low range of zero to 0.25 percent, from 4.25 percent at the end of 2007. In contrast, the ECB has eased by a relatively tame 150 basis points to 2.5 percent.

More dire U.S. economic data on Tuesday only added to expectations of further action from the Fed. Prices of single-family homes in October plunged a record 18 percent from a year earlier, while consumer confidence fell to a record low in December. For details, see [ID:nNYS004673] and [ID:nN30314773]

At the same time the U.S. central bank announced details of a plan to buy up to $500 billion of agency mortgage debt by the middle of 2009 [ID:nN21494092]. That splurge would be funded by expanding its balance sheet -- in effect printing more dollars -- and there was even talk of it buying longer-dated Treasury debt.

All of which helped 30-year Treasury bonds surge over 2 points in price on Tuesday, driving yields down almost 10 basis points to 2.55 percent.

That yield has fallen all the way from 4.30 percent as recently as mid-November and is now far below the euro zone 30-year yield of 3.53 percent, making the dollar less attractive from a pure interest rate perspective.

The odd one out in all this has been the Japanese yen, which has surged across the board this year even as the economy slid into recession and rates were cut to near zero.

That outperformance was largely the result of a massive unwinding of carry trades -- where investors used to borrow in yen to invest in higher yielding currencies.

While the yen was steady at 90.26 per dollar <JPY=> on Wednesday, that compares to 111.33 at the end of last year. Even the euro has shed around 22 percent of its value against the yen this year to hover around 127.45 yen <EURJPY=>. (Reporting by Wayne Cole; Editing by Jonathan Standing)

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