The euro fell the most against the dollar in almost two weeks on Thursday after the European Central Bank chief threw cold water on hopes of bold actions to contain the eurozone debt crisis. Investors, however, refrained from selling the single currency more aggressively ahead of a key European Union summit on Friday.
In a press conference following the ECB's decision to cut interest rates by 25 basis points, President Mario Draghi discouraged expectations the bank would massively step up buying of government bonds. He also said the eurozone's rescue fund should remain the main tool to fight bond market contagion, despite its clear limits, and that it was illegal for the ECB or national central banks to lend money to the IMF to buy eurozone bonds, appearing to veto one firefighting option under active consideration.
"By refusing to act as a backstop to the eurozone sovereign debt market, the ECB may have created the worst of both worlds scenario by essentially lowering the credit quality of the euro without providing any interest rate relief for the member nations, said Boris Schlossberg, director of currency research at GFT in Jersey City.
Traders said the market perceived the easing of collateral requirements for eurozone banks as riskier because the ECB is lowering lending standards. The euro fell to a session low of $1.3288 on Reuters data, its lowest since November 30. It was last at $1.3343, down 0.5 percent.
The single currency extended losses against the dollar after a senior German source said Germany rejected some measures in draft conclusions for Friday's summit, including giving the European Stability Mechanism (ESM) a banking licence and issuing common euro zone debt.
"It highlights the lack of unity and there is not much confidence in anything coming from the summit," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington. The dollar was little changed 77.69 yen. In the options market, the 25 delta one-month risk reversals for euro/dollar traded around -3.10 vols with a bias for euro puts, compared with 2.75 vols on Wednesday, suggesting traders are more bearish on the single currency. Implied volatilities rose to 14.30 percent, though still below their 50- and 100-day moving averages, suggesting that investors in general have become less pessimistic about the eurozone, with hedges coming down in price from previous highs.
Despite the ECB initiating measures to support bank lending and money market functioning, funding pressures in the eurozone increased. The benchmark three-month cross-currency basis swap, a gauge of dollar demand corresponding to the relative premium for swapping euro LIBOR for dollar LIBOR, traded at -121.500 basis points, from -115 basis points on Wednesday. Wider spreads typically reflect elevated demand to borrow US dollars in the currency forward market and often support the greenback's spot value against the euro.