Euro pressured by more bad news; dollar firmer

By Ian Chua

SYDNEY (Reuters) – The euro started the week on the backfoot following news of a German state election rout for Chancellor Angela Merkel’s conservatives, but expectations of an imminent rate hike by the European Central Bank looked set to limit its downside.

Failure to break through option barriers around $1.4250 last week also saw some traders pare long exposure on the common currency, although support around $1.4015/35 appeared to be holding for now.

“Clearly risks are rising, but not sufficient to tip the euro over the edge yet. There’s also a range of support on the way down, it’s not going to collapse even if it falls through $1.40,” said Greg Gibbs, a strategist at RBS, adding prospects of a rate hike was an important element holding up the currency.

The euro last traded at $1.4024, compared with $1.4065 late in New York on Friday. Early in the session, it was marked down to around $1.4020.

Chancellor Merkel’s conservatives lost power in a regional stronghold on Sunday, with early poll results showing the Greens, buoyed by Japan’s nuclear crisis, surging to their first premiership in the Baden-Wuerttemberg state.

This capped off a barrage of bad news for the euro last week including the collapse of the Portuguese government, the ensuing credit ratings downgrade, and a delay by euro zone leaders to increase a rescue fund.

Still, the ECB seems to be on track for a hike next month with Governing Board member Ewald Nowotny on Sunday saying it wanted to move toward a more “normal” monetary policy despite recent events in Japan.

The central bank was also reportedly near finalizing a liquidity facility for EU banks, which would be particularly crucial for Ireland’s battered banks.

With the common currency subdued, the dollar held on to Friday’s gains sparked by hawkish comments from a regional Fed official.

Philadelphia Federal Reserve Bank President Charles Plosser, a well-known inflation hawk, said on Friday the U.S. central bank will have to reverse its easy money policy in the “not-too-distant future” to avoid sowing the seeds of inflation.

That gave markets a reason to buy the greenback and take profits on over-stretched positions in other currencies, said David Watt, strategist at RBC Dominion Securities.

“That markets moved so forcefully on Plosser suggests that he was a convenient trigger for a market do what it wanted to do anyway,” he wrote in a report.

Plosser’s comments were supported by St. Louis Federal Reserve President James Bullard, who said on Saturday lengthening the “extended period” of low interest rates could encourage a liquidity trap.

Yet, Fed fund futures continue to imply little chance of an actual tightening for the rest of the year.

The dollar index climbed to one-week highs at 76.406 (.DXY: Quote, Profile, Research), pulling well away from a 15-month low of 75.340 set on March 21.

Against the yen, the dollar edged up to 81.43, but held in a thin range with investors still wary after a G7 coordinated intervention to weaken the Japanese currency earlier in the month, which put a floor at the March 17 record low near 77 yen.

Meanwhile, the higher-yielding Australian dollar was last at $1.0242, having hit a 29-year peak of against the U.S. currency at $1.0294.

The yen-weakening intervention and stronger risk appetite were factors underpinning the Aussie’s rise, but resistance around $1.03 should cap the Aussie for now, traders said.

Euro pressured by more bad news; dollar firmer