Dollar Drops to 19-Month Low Against Euro; Breaches $1.30 Level

By Kabir Chibber

Nov. 24 (Bloomberg) -- The dollar fell to its lowest in 19 months against the euro on speculation the Federal Reserve will lower interest rates early next year as central banks in Europe increase them.

The U.S. currency extended its losses after breaching $1.30 against the euro for the first time since April 2005, a level where traders had placed automatic orders to sell the dollar. The European Central Bank has raised rates to an almost four-year high and President Jean-Claude Trichet on Nov. 20 said inflation remains a threat. The Fed has left rates unchanged since August.

``The break of 1.30 is a strong signal that the dollar has to weaken,'' said Carsten Fritsch, a currency strategist at Commerzbank AG in Frankfurt. ``The sentiment for the dollar is negative. In the euro-zone, growth will remain strong.''

Against the euro, the dollar traded as high as $1.3109 and was at $1.3089 at 8:42 a.m. in New York, from $1.2945 yesterday. The dollar also fell to 115.63 yen, from 116.30, and to as low as $1.9351 versus the U.K. pound, the weakest in almost two years.

Fritsch said the dollar may drop to $1.35 by year-end.

The euro was at 151.35 yen, after reaching a record of 151.67 on Nov. 20.

Traders place automatic orders, or so-called stop-losses, at preset levels to sell the currency after it breaches certain key levels, such as $1.30.

``When we broke through $1.30 this morning that triggered an awful lot of stops,'' said Adam Cole, senior currency strategist in London at RBC Capital Markets. ``We think there's more to come from the ECB and that could push euro-dollar higher.''

The volume of trading today may be less than usual after public holidays yesterday in the U.S. and Japan.

Rates Gap

Economic advisers to President George W. Bush on Nov. 21 cut their forecasts for growth next year on a weaker housing market. Gross domestic product will increase 2.9 percent next year, slower than the 3.6 percent forecast in June, the Council of Economic Advisers said.

Traders are betting the Fed will cut borrowing costs in 2007. In contrast, interest-rate futures show traders expect the Frankfurt-based ECB to raise its main rate twice more to 3.5 percent by year-end, with one further increase by March 2007.

ECB policy maker Klaus Liebscher told Reuters today that the central bank must remain ``vigilant'' on inflation. Trichet and fellow council member Miguel Angel Fernandez Ordonez also this week said inflation is a risk.

Europe's central bank has lifted borrowing costs five times since December, to 3.25 percent, to stem inflation. The Federal Reserve has left its benchmark rate at 5.25 percent for the past three months, after 17 straight increases since June 2004.

`Wrong to Raise'

The rally in the euro may be curbed after Pervenche Beres, head of the European Parliament's economic and monetary committee, said the region's central bank would be wrong to push rates higher with the currency above $1.30.

``It's not good news for the European economy,'' she said in an interview in Berlin today. ``It's not the right time to raise interest rates.''

European stocks slumped today on speculation the stronger euro will hurt exports to the U.S., the region's biggest trading partner.

The extra yield investors earn on U.S. government bonds over those in Europe has shrunk to the lowest in 17 months, attracting investors to assets in the euro region and away from the dollar.

The narrowing yield premium on dollar-denominated debt may also encourage central banks to hold more of their foreign- exchange reserves in other currencies.

People's Bank of China Vice-Governor Wu Xiaoling said East Asia needs to reduce its reliance on dollar inflows because of the risk of a further slump in the currency. China's foreign- exchange reserves exceed $1 trillion, the world's largest.

Currency Reserves

Wu's comments were released today in an article circulated during a press conference in Beijing.

``China holds most of its reserves in the dollar and these comments may lead to speculation they will sell,'' said Tohru Sasaki, a strategist in Tokyo at JPMorgan Chase & Co. and a former chief currency trader at the Bank of Japan. ``Diversifying reserves always puts downward pressure on the dollar.''

The U.S. currency fell for three straight years through 2004 versus the euro and the yen as the country's trade deficit widened, reaching a record $1.3666 per euro on Dec. 30, 2004. It advanced against the euro and yen last year as the Fed pushed borrowing costs higher at every meeting.

The euro reached a five-month high to the dollar yesterday after the Ifo Institute said business confidence in Germany, Europe's largest economy, unexpectedly gained to the highest in 15 years.

The Ifo index rose to 106.8 from 105.3 in October, matching a 15-year high in June. Economists expected a drop to 105.2, according to a Bloomberg News survey.

To contact the reporter on this story: Kabir Chibber in London at kchibber@bloomberg.net .