Euro Snaps Five-Day Losing Streak on Rescue-Fund Bets

The euro rose against the dollar and the yen, snapping five days of losses, as speculation that European policy makers will boost the firepower of their rescue fund eased concern the region’s debt crisis will worsen.

The 17-nation currency strengthened versus the majority of its 16 most-traded counterparts as Spanish and Italian bonds advanced after Ewald Nowotny, a European Central Bank council member, said there were arguments in favor of giving the fund a banking license. The euro pared gains after sales of new U.S. homes unexpectedly fell in June. The pound slid after the U.K. economy contracted for a third consecutive quarter.

“Over the last few sessions we have seen the euro come off considerably, and investors have been very bearish,” Ravi Bharadwaj, a market analyst in Washington at Western Union Business Solutions, a unit of Western Union Co., said in a phone interview. “It’s possible that the upside surprise from the ECB comments triggered a massive short squeeze.” A short squeeze is when traders are forced to buy back a security whose price is rising after they sold it short, expecting the price to fall.

The euro gained 0.8 percent to $1.2158 at 5 p.m. New York time after dropping yesterday to $1.2043, the weakest level since June 2010. It has lost 4.1 percent this month. The shared currency rose 0.8 percent to 95.03 yen, paring its July loss to 6 percent. It slid yesterday to 94.12, the lowest since November 2000. Japan’s currency was little changed at 78.16 per dollar.

Worst Performer

The common currency has slumped 4.8 percent in the past three months, the worst performer of the 10 developed-market currencies tracked by Bloomberg Correlation-Weighted Indexes, as the region’s debt crisis deepened. The yen gained 8.7 percent, and the dollar strengthened 4.5 percent.

The South African rand gained against all of its major peers as Nowotny’s comments fueled risk appetite. The currency snapped a four-day losing streak against the greenback, appreciating 1.4 percent to 8.3965. Australia’s dollar climbed 0.8 percent to $1.0307.

Mexico’s peso strengthened as much as 1 percent to 13.5790 per dollar, the biggest intraday jump since July 13. It touched 13.7768 yesterday, the weakest since June 27.

“The move in the peso is really the embodiment of all the risk going on,” Mike Moran, a currency strategist at Standard Chartered Bank, said in a telephone interview from New York.

Volatility Decline

Implied volatility on three-month options for Group-of-Seven currencies declined for the first time in four days, reaching 9.54 percent, according to the JPMorgan G7 Volatility Index. It rose to 9.83 percent yesterday, the highest level this month. The average over the past five years is 12.4 percent.

Decreased volatility makes investments of currencies of nations with higher benchmark interest rates more attractive because there is less risk of market moves erasing profits.

Key rates are 5 percent in South Africa and 3.5 percent in Australia, versus zero to 0.25 percent in the U.S.

The dollar fell against most major peers before a report on July 27 that may show expansion in the world’s largest economy slowed in the second quarter. A Bloomberg News survey forecast gross domestic product grew at an annualized 1.4 percent, the slowest in a year, fueling bets the Federal Reserve will take further steps to boost the economy and debase the currency.

The Fed purchased $2.3 trillion of debt from 2008 to 2011 in two rounds of a stimulus strategy called quantitative easing.

“We have seen nothing but signs that give credence for the Federal Reserve to engage in greater quantitative easing over a short period of time,” Western Union’s Bharadwaj said.

U.S. Housing

The greenback pared losses against the euro after Commerce Department data showed demand for new U.S. homes unexpectedly dropped in June from a two-year high. Purchases decreased to a 350,000 annual rate, the weakest since January, the data showed. Economists in a Bloomberg survey forecast a pace of 372,000.

The euro may appreciate to $1.22 versus the dollar if stocks rally and risk appetite improves, Boris Schlossberg, New York-based managing director of foreign exchange at the investment advisory firm BK Asset Management, wrote today in a note to clients.

The common currency gained for the first time in six days after Nowotny’s comments on the bailout fund, the European Stability Mechanism. Granting a banking license to the ESM would give it access to ECB lending, easing concern its 500 billion-euro ($608 billion) cash reserves won’t be enough if Spain or Italy require aid amid the worsening debt crisis.

“There are pro arguments for this,” Nowotny, who heads Austria’s central bank, said in an interview in his office in Vienna yesterday. “It is not something that is only in the field of monetary policy, so this is part of a broad discussion.” He declined to elaborate.

Spanish Bonds

The yield on Spain’s 10-year bond dropped 25 basis points, or 0.25 percentage point, to 7.38 percent, and similar-maturity Italian yields declined 15 basis points to 6.45 percent.

“The market is a little overstretched after selling off pretty consistently,” Standard Chartered’s Moran said. “The Nowotny comments have proven to be a temporary re-think of the market’s perception of what the policy options are for Europe.”

The euro remained higher versus the dollar and yen as Moody’s Investors Service lowered its ratings outlook on 17 German banking groups to negative. The move followed the ratings company’s decision this week to cut the outlook on German sovereign and sub-sovereign ratings to negative.

The pound fell versus most major peers after the Office for National Statistics said the U.K.’s gross domestic product shrank 0.7 percent in the second quarter. Economists in a Bloomberg survey forecast a 0.2 percent decline.

Sterling weakened 0.8 percent to 78.44 pence per euro after rising to 77.55 pence on July 23, the strongest level since October 2008. The U.K. currency was little changed at $1.5498.

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