Euro Falls for Week on China's Yuan Change, German Election

Sept. 24 (Bloomberg) -- The euro fell for a third week against the dollar, the longest losing streak since May, after China widened the yuan's trading band against the European currency and Germany's election failed to produce a clear winner. China's central bank said yesterday it will allow the yuan to strengthen by as much as 3 percent from a daily fixed rate against the euro, from 1.5 percent previously. It kept the range against the dollar unchanged. "It poses significant risks for the euro going forward,'' said T.J. Marta, senior currency strategist at RBC Capital Markets in New York. "It's positive for the European economy, because a strong euro has already done a lot of damage. But it's not good for the euro.'' For the week, the euro dropped 1.6 percent to $1.2042, the lowest close since July 26, at 5 p.m. yesterday in New York, according to electronic foreign-exchange dealing system EBS. The European currency also declined 0.6 percent to 135.44 yen. The 12-nation currency also weakened as the interest-rate advantage of U.S. government debt over European bonds widened this week to the most in more than five years. The change by China's central bank came the same day finance ministers from the Group of Seven industrial nations met in Washington. China may face pressure to allow its currency to appreciate further after Japanese Finance Minister Sadakazu Tanigaki said China's policy change yesterday wasn't "vital.'' "The decision is pretty technical and it's not vital to how the country will manage its entire currency system,'' Tanigaki told reporters in Washington after a meeting with U.S. Treasury Secretary John Snow. "A big issue is how China will manage the yuan, and we must watch how they will manage it.'' China may allow further revaluations in its currency this year, said Jim O'Neill, global head of economic research at Goldman Sachs Group Inc. in London. "It should serve as a reminder of the tiny progress that's been made,'' said O'Neill. "The pressure from Washington might rise after this weekend.'' A stronger yuan would boost Chinese consumers' purchasing power for imports from Asia and make the country's exports less competitive against regional rivals. The yuan has risen less than 0.3 percent since the People's Bank of China revalued the currency on July 21. The yen surged 2.3 percent that day. The decision by China came almost two years to the day after the G-7 countries called for more flexible exchange rates in a statement following their meeting in Dubai. "The timing may have been designed to head off some pressure that might be brought to bear on China,'' said Tim Fox, a currency strategist at Dresdner Kleinwort Wasserstein in London. "It's more of a refinement than any sort of indication of a policy change. The markets may interpret it as leading a way toward a change, but we'd be cautious about doing that.''

The euro was also hurt this week after Germany's national election ended in a stalemate and Italian Finance Minister Domenico Siniscalco resigned. The European currency fell the most in a week after results showed neither German opposition leader Angela Merkel's Christian Democrats nor Chancellor Gerhard Schroeder's Social Democrats won a majority in the vote on Sept. 18. Both have said they will attempt to form a coalition to lead the country. "The bigger picture is you have got major problems in Europe,'' said Alan Kabbani, a currency trader in Charlotte, North Carolina at Wachovia Corp. "The dollar's going to continue to get stronger'' versus the European currency, he said.
Merkel said differences with the Greens are too great to schedule a further round of talks on forming a government, signaling that she's pinning expectations on a "grand coalition'' with Schroeder's party. Merkel needs the support of the Greens, Schroeder's coalition partners for the past seven years, to form a government with her ally, the pro-business Free Democratic Party, after the inconclusive election. The CDU and FDP and the ruling coalition each fell short of a majority in the election, the first of 16 in Germany since World War II to fail to produce a clear winner.
The dollar had its third weekly gain against the euro as some investors set aside concerns about Hurricane Rita and higher oil prices to focus on the benefits to the U.S. currency of the Federal Reserve's "measured'' rate increases.
The U.S. currency also gained for the week versus the yen, advancing 1 percent to 112.48 yen from 111.34, its second straight weekly advance.

"Another catastrophic storm hitting the Gulf Coast is also unlikely to change their outlook and the course of interest rates,'' said Michael Woolfolk, a currency strategist in New York at Bank of New York. "The Fed feels comfortable continuing on their rate-hike trajectory. It is very supportive for the dollar.'' Hurricane Katrina struck the U.S. on Aug. 29, killing more than 1,000 people and becoming the costliest natural disaster in U.S. history. The extra yield offered by 10-year U.S. Treasuries over comparable German bunds reached 1.19 percentage points yesterday, the widest since January 2000. UBS AG raised its forecast for the dollar versus the euro and the yen after the bank's economists this week increased their year- end target for U.S. interest rates. The bank raised its year-end forecast for the Fed's key interest rate to 4.25 percent from 4 percent after the central bank lifted its overnight lending rate between banks a quarter- point to 3.75 percent on Sept. 20. UBS was one of four of the 22 firms that trade directly with the Fed that had predicted no change, the first time since May they have disagreed. "We have raised our one-month dollar targets versus the euro and yen this week in recognition of the shift in Fed views,'' the bank's currency strategists, headed by Mansoor Mohi-uddin in London, wrote in a note to clients. UBS now expects the dollar to drop to $1.24 in one month, compared with its previous forecast of $1.27. Against the yen, it forecasts the dollar will trade at 109 in one month, up from a previous prediction of 108. The Fed's rate compares with the European Central Bank's benchmark rate of 2 percent and almost zero percent in Japan. Economists forecast the Fed will raise rates to 4 percent by year-end, according to the median estimate of 56 analysts surveyed by Bloomberg News from Aug. 31 to Sept. 8. The yield on the December federal funds futures contract rose to 4.035 percent today, up 7 basis points, or 0.07 percentage point, for the week.