Euro Weakens Before ECB on Bond-Purchase Speculation

The euro fell for the first time in four days against the dollar amid speculation the European Central Bank will expand its balance sheet to stem the rise of the region’s sovereign-bond yields.

The 17-nation currency dropped from almost a two-week high versus the yen even as Spanish bonds extended a rally before the bank’s next policy decision on Aug. 2. ECB President Mario Draghi pledged last week to do whatever it takes to preserve the currency, suggesting policy makers may intervene in bond markets. Sweden’s krona rallied as the economy expanded more than analysts predicted.

“We’ve had the weekend to digest Draghi’s comments; the euro is going to come under continued selling pressure, and any further easing is going to viewed as euro-negative,” said Michael Woolfolk, senior currency strategist in New York at Bank of New York Mellon Corp. “The euro is considerably oversold at this point, so you could see some profit-taking just ahead of the decision.”

The euro dropped 0.5 percent to $1.2260 at 5 p.m. New York time, after strengthening 1.4 percent last week. It was poised for a 3.2 percent loss for July and a 5.4 percent drop for the year. The single currency declined 0.9 percent to 95.85 yen after climbing to 97.34 on July 27, the strongest level since July 17. The yen gained 0.4 percent to 78.18 per dollar.

“You could see a challenge of $1.20 before the decision, and I would expect going into the decision and shortly thereafter you could get back to the $1.23 area,” Woolfolk said. He expects the euro to weaken to $1.16 in coming months.

Volatility Rises

One-week implied volatility for euro-dollar options, which signals the expected pace of currency swings, was at the highest level since June 15, 12 percent. The year-to-date average is 10.2 percent.

“The euro is going to trade on speculation on whether the ECB is going to be doing bond buying,” Steven Englander, head of Group-of-10 currency strategy at Citigroup Inc. in New York, said in a radio interview today on “Bloomberg Surveillance” with Tom Keene. “I’m on the euro-bullish side for at least this week.”

Analysts surveyed by Bloomberg predict the currency will end 2012 at $1.23.

Spain’s 10-year government bond yields traded at 6.61 percent after reaching a euro-era high of 7.75 percent July 25.

U.S. Treasury Secretary Timothy Geithner and German Finance Minister Wolfgang Schaeuble earlier backed a commitment by European leaders to defend the euro area, while failing to mention its weakest link, Greece. They issued a joint statement after they held talks on the German North Sea island of Sylt today.

Not Sufficient

While the ECB’s commitment to preserve the euro is necessary, it’s not sufficient by itself to resolve the debt crisis, Moody’s Investors Service said in a report.

“In both situations, where the ECB does more or less, you see the euro lower,” said Aroop Chatterjee, a currency strategist at Barclays Plc in New York. “In a world where the ECB does less, the risks remain elevated and people will worry about the potential for a breakup. We’re in the other world where the ECB does more in terms of sovereign-bond purchases or easing of policy. This is typically negative for the currency.”

The euro has weakened 3.4 percent in the past month, the worst performer of the 10 developed-nation currencies tracked by Bloomberg Correlation-Weighted Indexes. The dollar rose 0.2 percent and the yen gained 2.4 percent.

Krona Climbs

Sweden’s krona climbed as much as 1.7 percent to 8.3173 against the euro, its strongest since September 2000. The currency rose for a fourth day against the dollar, gaining 1.2 percent to 6.7870 and touching 6.7842, the highest since May 4.

The Swedish economy grew 1.4 percent in the quarter through June, after advancing a revised 0.9 percent the previous three months, Stockholm-based Statistics Sweden said.

Brazil’s real and South Africa’s rand were the biggest losers among major currencies. The real slid 1 percent to 2.0411 per dollar, and the rand lost 0.5 percent to 8.2013 to the greenback.

The dollar may extend its decline against the yen to its weakest in five months should the U.S. currency breach its lowest level from last week, according to UBS AG analysts citing trading patterns.

Downside Skew

“The directional risk remains skewed to the downside” as long as so-called resistance holds at 78.82 yen, Richard Adcock, a London-based fixed-income technical strategist, wrote in an e- mailed note to clients today. A break below last week’s low, which was 77.94 yen on July 23, may open the way for the U.S. currency to slip to 77.65 yen, Adcock wrote. Resistance is an area on a chart where sell orders may be clustered.

Demand for the dollar was tempered before the Federal Reserve starts a two-day meeting tomorrow amid speculation the central bank will signal additional stimulus.

Fed Chairman Ben S. Bernanke said this month policy makers are “looking for ways to address the weakness in the economy should more action be needed to promote a sustained recovery in the labor market.” While the central bank refrained from introducing a third round of asset purchases at its June meeting, Bernanke indicated it’s an option. It bought $2.3 trillion of securities from 2008 to 2011 to spur growth.

U.S. investors repatriated $48.9 billion from December to May, the first time they brought assets home during a six-month stretch since the period following the failure of Lehman Brothers Holdings Inc. in 2008, according to Treasury Department data compiled by Bloomberg. Inflows into funds that focus on U.S. bonds more than doubled to $157 billion in the first six months from $65 billion during the same period a year earlier, while international bond investments were unchanged, according to TrimTabs Investment Research.

To contact the reporter on this story: Allison Bennett in New York at abennett23@bloomberg.net

To contact the editor responsible for this story: Robert Burgess at bburgess@bloomberg.net

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