Euro drops on debt fears, but rate view still reigns

NEW YORK: The euro succumbed to sovereign debt fears on Friday, but the single-currency should remain range-bound or even rebound against the dollar as loose US Federal Reserve monetary policy goes head-to-head with a hawkish European Central Bank.

Peripheral sovereign debt concerns have mostly been outweighed by rate expectations this year, but nevertheless the euro has suffered from setbacks along the way, with Friday no exception after Moody's cut Ireland's rating to just above "junk" status.

In early afternoon New York trading, the euro was down 0.4 percent at $1.4436, well below a 15-month high of $1.4521 touched earlier this week. The euro was down about 0.3 percent so far this week.

Traders said market ran stop orders below $1.4430, pushing the euro to session lows at $1.4407 on electronic trading platform EBS.

The options market suggests euro zone debt worries are not at the forefront of investors' minds. Benchmark volatilities implied by one-month at-the-money euro/dollar options was around 9.35 percent on Friday, near a one-year low.

Six-month and one-year implied vols remained elevated though, trading at 11.45 percent and 12.25 percent respectively.

Several top Federal Reserve officials have sounded reassuring about inflation, and data on Friday supported that stance.

Data showed US core consumer prices for March were contained, suggesting the Fed was still a long way away from tightening monetary policy.

To many economists the data affirmed expectations that the Fed would not raise rates until early next year.

The ECB. meanwhile, raised rates to 1.25 percent from 1 percent last week, its first rate hike since July 2008.

Euro zone inflation numbers surprised on the upside, reinforcing views the ECB will continue to raise rates in the coming months.

"A year from now, the ECB may have navigated the exit from accommodative policies, at the point at which the FOMC (Federal Open Market Committee) will be about to raise rates," said Jens Larsen, chief European economist at RBC Capital Markets in London.

"If the ECB hike does not cause a significant slowing of growth in the euro area, or a sharp deterioration in the periphery, then the pre-emptive strategy may well be judged successful."

Investors are pricing in the chances of two more ECB rate increases before the end of this year

"The interest rate differential argument has clearly supported the euro the last few weeks," said Greg Salvaggio, senior vice president for capital markets at Tempus Consulting in Washington.

"The ECB has hiked rates and will probably hike again by the end of the summer and now the question is what will the Fed do. Clearly this benign inflation data that we got this morning won't push the Fed quickly to hike rates."

Market players said the euro could find the going tough above $1.45 given concerns about sovereign debt problems, which escalated this week as fears about a possible Greek restructuring intensified.

The US stock market. meanwhile, is reflecting a "risk-on" stance, with the Standard & Poor's 500 stock index up 5 percent this year.

Charles Schwab Corp, the largest US discount brokerage, posted higher-than-forecast earnings. Chairman Charles Schwab said in a statement that clients had reduced their cash holdings at Schwab to levels not seen since before the financial crisis of 2008 and are investing more money in stocks.

The dollar was down 0.4 percent at 83.12 yen, but losses were limited. The greenback has fallen in six of the last seven sessions and was on track for its worst weekly performance in about nine months with losses this week of 2.1 percent.