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Euro surges on ECB policy stance

Tuesday, December 10 14:37:51

The euro rose to a six-week peak against the dollar today and hovered just below a five-year peak versus the yen, helped by higher short-term market rates and the European Central Bank's reluctance to ease policy again.

Tighter money market conditions in the euro zone, as reflected in the rise of two-year swap rates partly due to year-end factors and the ECB's unwillingness to ease monetary policy soon to fight disinflation, are seeing rate differentials more in favour of the euro.

Against the dollar, the euro was slightly higher at $1.3745 , not far from a two-year high of $1.3833 set in late October. The euro hit a five-year peak of 142.19 yen, a high not seen since October 2008.

The euro has gained over 1.5 percent against the dollar and 2.7 percent versus the yen since the ECB last week refrained from following up on November's rate cut and said it has yet to come up with a detailed plan of which tools to use and when.

"It is a combination of lack of urgency on the part of the ECB and the tighter liquidity conditions that are driving the euro higher," said Alvin Tan, currency strategist at Societe Generale. "The year's high of $1.3833 is definitely in play and we could expect it to go even higher."

Liquidity conditions in the euro zone money market usually tighten towards the end of the year as banks refrain from lending to each other. This year another factor driving euro strength is European banks repatriating funds to shore up their capital bases ahead of an ECB asset quality review.

The review will be based on banks' balance sheets at the end of 2013.

Highlighting this demand, three-month eurodollar cross currency basis swaps moved into positive territory for the first time since 2008. In other words, euro zone banks are paying a premium to buy euros in exchange for dollars.

"Unless the ECB identifies a way and announces a method to counter these tight liquidity conditions, euro/dollar could be dragged as high as $1.39 by year-end," said Chris Turner, head of currency strategy at ING. (Reuters)