Euro, Pound Tumble on Bets Europe’s Central Banks to Cut Rates

Oct. 22 (Bloomberg) — The euro fell below $1.28 for the first time since November 2006 and the pound tumbled to a five- year low on speculation Europe’s central banks will cut interest rates as the global economy heads for a recession.

The single European currency also slid to the weakest in almost five years versus the yen as global stocks declined, encouraging investors to sell higher-yielding assets and pay back low-cost loans in Japan. The pound dropped to a one-week low versus the euro after Bank of England Governor Mervyn King said the U.K. is probably in a recession.

“The market came to realize that many more rate reductions are needed in Europe,” said Robert Blake, a strategist in Boston at State Street Global Markets LLC, which has $15.3 trillion in assets under custody. “Dollar repatriation has much further room to run.”

The euro dropped 1.7 percent to $1.2843 at 3:30 p.m. in New York, from $1.3063 yesterday, after touching $1.2743. It fell 4.3 percent to 125.16 yen from 103.80, after reaching 124.97, the lowest level since November 2003. Japan’s currency rose 2.8 percent to 97.35 per dollar from 100.14.

Sterling declined 2.2 percent to $1.6334 after touching $1.6139, the lowest since September 2003. It dropped as much as 3.4 percent, the biggest decline since September 1992, when investor George Soros drove the currency out of Europe’s system of linked exchange rates. The pound slid for a third day against the euro, weakening 0.8 percent to 78.75 pence.

Emerging-market currencies weakened as Argentina’s planned seizure of private pension funds stoked concern the nation faces its second default this decade. The government of President Cristina Fernandez de Kirchner proposed yesterday taking control of 10 funds, including units of HSBC Holdings Plc and Banco Bilbao Vizcaya Argentaria SA.

Russia’s Ruble

Russia’s ruble fell for a sixth day against the dollar to the lowest level in two years, dropping as much as 1.1 percent to 26.9916. The South Korean won lost 3.1 percent to 1,363.13 per dollar, Brazil’s real dropped 5.9 percent to 2.3790, and Mexico’s peso declined 3.4 percent to 13.706. Argentina’s peso was little changed at 3.2238 per dollar as traders said the central bank sold reserves to shore up the currency.

The declines caught companies investing in currency derivatives, or financial instruments derived from stocks, bonds, loans, currencies and commodities, on the wrong side of the trade.

Vitro SAB, the century-old Mexican glassmaker which sells in more than 45 countries, may be forced into creditor protection because of derivative losses, according to analysts at ING Groep NV and Deutsche Bank AG. Taesan LCD Co., the South Korean supplier of flat-screen parts to Samsung Electronics Co., failed on Sept. 16 because of losses on derivatives.

Worldwide Recession

The euro extended losses today on speculation efforts by global governments and central banks to revive credit markets will fail to avoid a worldwide recession.

“What is becoming clear is that the steps taken to shore up the capital bases of the major financial institutions and to provide liquidity may well prove successful, but those steps in themselves will not stem the appetite for deleveraging further,” Derek Halpenny, head of currency research at Bank of Tokyo-Mitsubishi in London, wrote in a note to clients today.

Investors bet the European Central Bank will lower borrowing costs by another 0.75 percentage point by June after cutting the main refinancing rate by a half-percentage point to 3.75 percent on Oct. 8, part of coordinated reductions by major central banks.

The implied yield on the three-month Euribor contract expiring in June fell to 3.15 percent, the lowest level in three years. The yield has been 0.23 percentage point higher than the benchmark rate on average over the past year.

Risk Reversal

The premium traders demand to buy options granting them the right to sell euros against the dollar rose today to the most in at least five years. The currency’s one-month 25-delta risk- reversal rate against the dollar widened to minus 1.48 percent, the most since Bloomberg began collecting data in October 2003. The premium is the amount traders demand for euro puts, which allow for sales, over calls, which grant the right to buy.

Citigroup Inc. told its clients to “take profit” on its bet on the decline of the euro versus the dollar today, according to a research note written by Tom Fitzpatrick, global head of currency strategy at Citigroup Global Markets in New York. The bank initiated the recommendation on Oct. 20, when the dollar was at $1.33 per euro.

The dollar has gained 20 percent since touching a record low of $1.6038 per euro on July 15 on speculation the U.S. currency will benefit as the European economy slows.

“I am short on the euro-dollar,” said Benedikt Germanier, a currency strategist at UBS AG in Stamford, Connecticut. “It’s a strong trend. It’s more about psychology than fundamentals.”

U.S. investors have repatriated about $60 billion of the nearly $1 trillion in foreign stocks and bonds purchased since 2003, leaving an “enormous pool of capital” that may flow back into the U.S. and bolster the dollar, according to an Oct. 16 note by Citigroup.

Weaker Pound

The British pound fell for a fourth day against the greenback after a report yesterday showed U.K. manufacturing confidence dropped to its weakest level in almost three decades.

“It now seems likely that the U.K. economy is entering a recession,” BOE Governor King said in a speech to executives in Leeds, England, yesterday. “The balance of risks to inflation in the medium term shifted decisively to the downside.”

Policy makers voted unanimously to lower the benchmark U.K. interest rate by a half-percentage point to 4.5 percent in an emergency meeting on Oct. 8, according to minutes of the decision released by the Bank of England today in London. The nine-member Monetary Policy Committee said the economy had “deteriorated substantially,” which would slow inflation from more than double the 2 percent target.

The pound may weaken toward $1.60, wrote Kevin Edgeley, a technical analyst at Goldman Sachs Group Inc. in London, citing weekly and monthly stochastic and trend strength indicators.

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