FOREX-Euro recovers from 6-week low vs dollar, but gains seen capped

November 4, 2013

* Euro hits lowest since Sept. 18, implied vols rise

* ECB meeting on Thursday key for common currency

* ECB may flag deposit rate cut to push euro lower

By Anirban Nag

LONDON, Nov 4 (Reuters) - The euro earned a reprieve on Monday after business surveys showed manufacturing in the euro zone accelerated as predicted in October, though many investors were looking to sell it at higher levels.

Speculators and investors are rapidly cutting bullish bets on the euro and their selloff is likely to accelerate in coming days on mounting expectation that the European Central Bank may loosen policy in the near term.

The euro was up 0.2 percent at $1.3510, gaining ground after the manufacturing Purchasing Managers' Index (PMI) survey. Earlier, the euro fell to $1.3442 on trading platform EBS, its lowest level since Sept. 18 in thin trade in Asia. Despite its recovery, the euro is well below a two-year high of $1.3833 struck on Oct. 25.

The drop in the euro, which shed more than 2 percent last week, triggered a rush to hedge against further weakness. One-month euro/dollar implied volatility, a gauge of how choppy a currency is expected to be, jumped to its highest in two months at 7.525 percent.

Traders said the euro is likely to stay under pressure before the ECB's policy meeting on Thursday. After data last week showed a plunge in the euro area's inflation rate, a growing number of banks, including UBS and RBS analysts, believe that a cut in the refinancing rate could come as soon as Thursday.

The ECB's refinancing (refi) rate is at 0.5 percent.

"The PMIs have given some relief to the euro, but we think there are considerable downside risks to business activity," said Manuel Oliveri, FX strategist at Credit Agricole.

"While we don't expect the ECB to cut the refi rate this week, given the downside risks to inflation from a stronger currency, we expect (ECB chief) Mario Draghi to possibly flag a cut in the deposit rate. That would be negative for the euro."

A cut in the deposit rate, at which banks park excess cash with the ECB, to negative territory would make holding the euro expensive and force investors to sell it. It would also make the euro a funding currency for carry trades, where investors borrow in a cheap currency to buy a higher-yielding one.

"We remain of the view that the euro will continue to struggle and investors will fade into rallies," said Jeremy Stretch, head of currency strategy at CIBC World Markets. "The bias remains for it to ease as markets drive the ECB to address disinflationary pressures building in the euro zone."

The euro's bounce nudged the dollar index down from a six-week high of 80.930 hit in Asia. It last stood at 80.586, down 0.15 percent on the day.

The dollar had risen in Asia after comments from Federal Reserve Bank of Dallas President Richard Fisher. Speaking at a conference of business economists in Sydney, Fisher said he was concerned that corporate credit spreads have narrowed too much and added that he does not see the Fed's balance sheet rising to $6 trillion or more.

The Australian dollar edged higher, supported by stronger than expected retail sales. It rose 0.7 percent to $0.9505 , edging away from Friday's three-week low of $0.9421.