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

Reuters

* 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 onMonday after business surveys showed manufacturing in the eurozone accelerated as predicted in October, though many investorswere looking to sell it at higher levels.

Speculators and investors are rapidly cutting bullish betson the euro and their selloff is likely to accelerate in comingdays on mounting expectation that the European Central Bank mayloosen policy in the near term.

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

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

Traders said the euro is likely to stay under pressurebefore the ECB's policy meeting on Thursday. After data lastweek showed a plunge in the euro area's inflation rate, agrowing number of banks, including UBS and RBS analysts, believethat a cut in the refinancing rate could come as soon asThursday.

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

"The PMIs have given some relief to the euro, but we thinkthere 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 thisweek, given the downside risks to inflation from a strongercurrency, we expect (ECB chief) Mario Draghi to possibly flag acut in the deposit rate. That would be negative for the euro."

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

"We remain of the view that the euro will continue tostruggle and investors will fade into rallies," said JeremyStretch, head of currency strategy at CIBC World Markets. "Thebias remains for it to ease as markets drive the ECB to addressdisinflationary pressures building in the euro zone."

The euro's bounce nudged the dollar index down from asix-week high of 80.930 hit in Asia. It last stood at80.586, down 0.15 percent on the day.

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

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

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