Dollar Heads for Biggest Quarterly Loss Against Euro Since 2004

By Kim-Mai Cutler

March 31 (Bloomberg) -- The dollar headed for its biggest quarterly loss against the euro since 2004 after inflation accelerated in the common-currency bloc, giving the region's central bank more reason to keep interest rates unchanged while the Federal Reserve lowers borrowing costs.

The dollar earlier fell to near a record low after a preliminary European Union report showed consumer-price growth quickened to the fastest pace in almost 16 years in March. European Central Bank policy maker Erkki Liikanen said today inflation threats are growing. The pound fell to an all-time low against the euro, posting its largest-ever quarterly decline, after U.K. house prices dropped for a sixth month.

``The market wants to push the euro higher,'' said Stephen Jen, the London-based head of foreign-exchange research at Morgan Stanley. ``Given the circumstances, the ECB has no choice: it will not ease. There aren't convincing signs euroland is slowing and inflation pressures remain high and are accelerating.''

The dollar was at $1.5797 per euro by 7:30 a.m. in New York, from $1.5796 on March 28, after earlier slipping to $1.5834. The European common currency has gained 8.2 percent this quarter, the most since December 2004. The euro may rise to $1.64, before declining to around $1.40 once the 15-nation economy slows and the ECB reduces interest rates, Jen predicted.

The yen declined to 99.69 per dollar, from 99.23 at the end of last week, and to 157.46 per euro from 156.79.

Europe's single currency advanced to 79.68 pence against the pound and traded at 79.67 pence after research company Hometrack Ltd. said the average cost of a home in England and Wales declined 0.2 percent this month. Other high-yielding currencies such as the Australian and New Zealand dollars also declined as stocks dropped.

ECB, Fed

The ECB has kept its key refinancing rate at a six-year high of 4 percent since June, while the Fed has slashed its target rate 3 percentage points since September to prevent the economy tipping into a recession. Investors increased bets the Fed will cut its target rate for overnight lending between banks by half a percentage point to 1.75 percent on April 30, futures on the Chicago Board of Trade showed.

Consumer prices in the euro area rose 3.5 percent in March, the highest rate since June 1992, the EU's statistics office in Luxembourg said. Economists surveyed by Bloomberg News had expected 3.3 percent.

``While the outlook for growth has become more subdued, inflation in the euro area has gathered pace,'' said Liikanen, who is also governor of the Bank of Finland, in a statement today in Helsinki. ``Inflation expectations have also hardened.''

`Deep Recession'

Conditions ``in favor of the euro over the dollar have been unprecedented,'' said Michael Klawitter, a currency analyst in Frankfurt at Dresdner Kleinwort, who says the euro may rise above its all-time high versus the dollar this week. ``We are seeing a deep recession in the U.S. which took a while for the market to realize and then we had sharp monetary easing by the Fed.''

The Institute for Supply Management will say tomorrow its factory index fell to 47.5 this month, the lowest level since April 2003, according a Bloomberg survey of economists. A reading below 50 signals contraction. On April 2, the U.S. Commerce Department will report factory orders in February dropped 0.8 percent, a separate survey showed.

``The state of the U.S. economy exposes the dollar to selling pressure,'' said Masanobu Ishikawa, general manager of foreign exchange at Tokyo Forex & Ueda Harlow Ltd., Japan's largest currency broker. ``The subprime loan problem is deep- rooted and damaging for sentiment.''

Dollar Index

The U.S. Dollar Index traded on ICE futures in New York, which tracks the currency against those of six trading partners, has lost 6.6 percent this year, dropping to a record 70.69 on March 17. It traded at 71.64 today, from 71.68 on March 28.

The slide in the dollar to record lows has fueled speculation that Arab Gulf nations may drop their pegs against the U.S. currency as they battle to contain inflation.

Gulf central bank governors will hold the first of two meetings this year in Doha, Qatar, on April 6-7 to discuss monetary and currency policy.

The yen fell against the dollar as banks in Japan sold mutual funds focused on overseas assets, following the currency's biggest quarterly gain since 1999.

Finance companies are seeking to raise the equivalent of $3.3 billion on the last day of the fiscal year for funds focused on stocks and bonds in Brazil, Russia, India, China and Thailand, data compiled by Bloomberg show. Japan's benchmark interest rate of 0.5 percent has encouraged investors to buy higher-yielding assets overseas, after the yen's 12 percent gain this quarter.

``There's interest to sell yen for the mutual funds being launched,'' said Tokichi Ito, deputy general manager of foreign exchange in Tokyo at Trust & Custody Services Bank Ltd., a unit of Japan's second-largest publicly traded lender. ``There's consistent demand for overseas assets in Japan.''

High-yielding currencies such as the New Zealand and Australian dollars declined. New Zealand's currency slipped 1.2 percent to 78.82 U.S. cents after a report also showed business confidence dropped to a 17-year low in March. The Australian dollar weakened 0.5 percent to 91.26 U.S. cents.

To contact the reporter on this story: Kim-Mai Cutler in London at kcutler@bloomberg.net