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Friday April 7, 2006 - 10:48:40 GMT
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FOREX - Euro falls as ECB quells May rate hike expectations

FOREX-Euro falls as ECB quells May rate hike expectations
Fri Apr 7, 2006 6:41 AM ET11

By Natsuko Waki

LONDON, April 7 (Reuters) - The euro dipped further on Friday from recent 7-month highs versus the dollar and record levels against the yen after the head of the European Central Bank on Thursday poured cold water on market expectations of a May rate hike.

ECB President Jean-Claude Trichet surprised investors, following the bank's decision to hold interest rates at 2.5 percent, when he said the ECB disagreed with markets which had priced in a 100 percent probability of a hike next month.

This triggered a sell-off in the euro, but clear hints by the ECB chief that a rate rise could come in June reassured investors that they were not wrong to expect the bank's gradual monetary tightening to continue.

"May rate hike expectations were so high but Trichet disappointed the market. We are seeing the correction from a strong move to $1.23," said Antje Praefcke, currency strategist at Commerzbank in Frankfurt.

"But the euro will remain supported. The market will see a rate hike in June and is more hawkish on the ECB than the Fed. The Fed will raise rates but there may be a pause in the summer."

By 1037 GMT, the euro slipped 0.3 percent on the day to $1.2183 , 1-1/2 cents off a seven-month peak of $1.2333 hit before the ECB's remarks on Thursday.

It was down 0.4 percent at 143.41 yen , having hit 144.92 on Thursday, its highest level since the launch of the single currency in January 1999.

Euro selling continued as some market players also sought to reduce their long euro positions ahead of the U.S. employment report due at 1230 GMT.

Economists in a Reuters poll expect the non-farm payrolls data to show a gain of 190,000 jobs in March, compared with an increase of 243,000 jobs a month earlier. The unemployment rate is forecast to hold steady at 4.8 percent.

The dollar was steady at 117.67 yen .


Investors will look to the U.S. payrolls data later on Friday to gauge the state of the U.S. economy and for clues on how much longer the Federal Reserve wil continue its monetary tightening campaign.

Recent comments by Fed officials have fuelled speculation that the end of a nearly two-year long tightening policy could be in sight, putting pressure on the dollar. The Fed has raised rates 15 times since mid-2004, pushing its funds rate to 4.75 percent.

Adding to the dollar's woes, Chicago Fed President Michael Moskow said on Thursday the United States faces a risk that Asian central banks which are still hungry for U.S. assets will one day reach their limit and reinvest at home.

Talk of diversification out of dollars in Asia and the Middle East had put an extra burden on the dollar earlier this week.

"(The market has been) looking at the dollar itself in terms of a likely cyclical deterioration, a renewed focus on structural deficit concerns and also with recent discussion in terms of FX reserve diversification," said Adam Baines, currency strategist at Citigroup.

Nevertheless, the dollar was seen firmly supported between 115.50 and 119.50 yen -- a range for the past two months that most traders think will persist into the near future.

Counting on such range-bound trade, some speculators have resumed yen carry trades, dealers said. In such trades investors borrow the Japanese currency at near-zero interest rates and invest in higher-yielding currencies, such as the dollar.

Expectations that the Bank of Japan will start tightening credit in the third quarter of this year have boosted 10-year Japanese government bond yields by about 50 basis points in the past three months.

© Reuters 2006. All Rights Reserved.


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