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BLBG: Euro Drops Versus Dollar After ECB Keeps Interest Rates Steady
By Andrew MacAskill and Kim-Mai Cutler

Oct. 2 (Bloomberg) -- The euro fell against the dollar on speculation the European Central Bank will signal the risks of a recession have intensified, boosting speculation policy makers will be forced to lower borrowing costs by year-end.

Europe's common currency traded near the lowest level in more than a year versus the dollar as policy makers left the key rate at 4.25 percent today. All 58 economists surveyed by Bloomberg expected no change. ECB President Jean-Claude Trichet will give a statement about the decision at 2:30 p.m. in Frankfurt.

``It will be all eyes on Trichet,'' said Jeremy Stretch, a senior strategist in London at Rabobank International, the third- largest Dutch bank. ``It may be the case that the ECB is pressured into lowering policy rates and the longer they wait, the bigger the penalty paid by the euro in terms of deteriorating growth.''

The euro declined to $1.3883 as of 12:46 p.m. in London, from $1.4009 yesterday, and traded earlier at $1.3856, the lowest level since Sept. 18, 2007. The single currency has fallen 13 percent against the dollar after climbing to a record high of $1.6038 on July 15. It was at 146.24 yen, from 148.11 yesterday.

Manufacturing and services contracted for a fourth month in September in the 15-nation euro region, a report showed yesterday. The European Commission, the executive arm of the European Union, last month cut its 2008 growth forecast for the euro area to 1.3 percent from 1.7 percent after the economy shrank in the second quarter.

Financial Turmoil

Financial-market turmoil prompted Belgium, the Netherlands and Luxembourg to bail out Fortis, the largest Belgian financial- services company, this week. Germany also had to rescue Hypo Real Estate Holding AG, the nation's second-biggest commercial-property lender.

The U.S. currency earlier rose against 14 of its 16 most- actively traded peers as demand for dollar funding increased amid the seizure in the money markets. The dollar also advanced after the Senate approved a $700 billion bank-rescue bill, bolstering expectations the U.S. will act faster than Europe to address the credit squeeze.

European producer-price growth slowed in August from an 18- year high in the prior month as oil prices slid from a record, easing inflationary pressures , the European Union statistics office in Luxembourg said today.

Producer Prices

Producer prices in the 15 euro nations rose 8.5 percent from a year earlier after increasing by 9.2 percent in July, the highest since the data series began in 1990. Oil has fallen by about 33 percent since reaching an all-time high of $147.27 a barrel on July 11.

The ECB kept its key rate unchanged at its meeting on Sept. 4, when Trichet said the region is undergoing an ``episode of weak activity.'' The economy contracted by 0.2 percent in the second quarter, the government said Sept. 3. Its report for the third quarter is due Nov. 14. Policy makers raised the benchmark rate in July by a quarter point after inflation accelerated to twice its 2 percent ceiling.

Traders have raised bets on a rate cut in coming months. The implied yield on the Euribor futures contract expiring in March was at 4.31 percent today, from 4.77 percent a month ago.

The ECB will lower borrowing costs in December as financial turmoil increases growth risks, JPMorgan Chase & Co. and Goldman Sachs Group Inc. said two days ago, revising their forecasts.

Rate Predictions

JPMorgan's David Mackie, the chief European economist in London, had previously forecast the ECB would start cutting in March and now predicts the benchmark rate will fall to 2.75 percent by the end of 2009, compared with 3.5 percent before. Goldman's Erik Nielsen, the chief European economist in London, who had expected the benchmark to stay at 4.25 percent through the middle of 2009, sees three quarter-point reductions by then.

The U.S. Senate voted 74-25 in favor of legislation that links the rescue plan for financial companies to an increase in bank-deposit-insurance limits and tax breaks, after the House of Representatives rejected an earlier version of the bill. The House is likely to vote on the latest version tomorrow, said Brendan Daly, a spokesman for House Speaker Nancy Pelosi.

Europe has yet to follow the U.S. with any bailout proposals. France and Germany clashed over whether to create a fund to rescue beleaguered banks. French Finance Minister Christine Lagarde told the German newspaper Handelsblatt a package is needed to help ``smaller'' European states ``threatened with a banking failure.'' German finance ministry spokesman Torsten Albig told reporters in Berlin yesterday his government ``doesn't support the plan.''

Borrowing Premiums

``Europe hasn't yet taken steps in a unified manner,'' said Akifumi Uchida, deputy general manager of the marketing unit in Tokyo at Sumitomo Trust & Banking Co., Japan's fifth-largest bank. ``Market consensus is that the U.S. bill will eventually pass in some kind of form. The package is likely to reduce worries over the U.S. and bolster the dollar.''

Foreign banks are paying near the highest premiums in at least a decade to borrow in dollars in the swaps market even after the Federal Reserve increased funds available to other central banks this week to $620 billion.

``The ability to secure funds in the money market hasn't improved in the slightest,'' said Akio Shimizu, chief manager of foreign-exchange trading in Tokyo at Mitsubishi UFJ Trust & Banking Corp., a unit of Japan's largest publicly listed lender. ``This should support the dollar as banks that need the currency will simply buy it outright in the foreign-exchange market.''

To contact the reporters on this story: Andrew MacAskill in London at amacaskill@bloomberg.net; Kim-Mai Cutler in London at kcutler@bloomberg.net