Euro rises but debt worries stay; Fed looms

The euro edged higher against the dollar on Friday but sentiment remained shaky after an agreement by nearly all European Union leaders to build a closer fiscal union failed to allay concerns about the region's debt crisis.

Developments in Europe's debt markets should continue to dominate the market's attention next week, while the Federal Reserve's last policy meeting of the year could prove a non-event as no new action is expected.

Twenty-six of the 27 leaders agreed to pursue tighter integration with stricter budget rules in the euro area but investors are uncertain whether and when more decisive action would be taken to stem a debt crisis that now threatens France and even economic powerhouse Germany.

"While many promises were made to stick to the rules of keeping debt at manageable levels, there were no tools offered that would supply an immediate and tangible benefit to the area," said Brendan McGrath, senior analyst at Western Union Business Solutions in Victoria, British Columbia.

The euro rose 0.2 percent to $1.3370, having climbed as high as $1.3433 after Reuters reported that China's central bank plans to create a $300 billion vehicle to manage investment funds in the United States and Europe.

On the week, the euro fell 0.5 percent against the dollar.

Analysts said it was unlikely European leaders had done enough to convince the European Central Bank to significantly raise the amount of bonds it buys from heavily indebted countries. Concerns also remained that implementation of tougher budgetary disclipline is going to be difficult.

The ECB has capped the maximum purchase of euro zone sovereign bonds at 20 billion euros a week for now and is not considering bigger action, ECB sources said. On Thursday, ECB President Mario Draghi discouraged expectations the bank would massively step up buying of government bonds.

Italian government bond yields jumped back towards unsustainable levels before easing on reported ECB buying. Italy and Spain are scheduled to issue new debt next week and their borrowing costs are likely to continue to rise.

"The developments at yesterday's ECB meeting and today's EU summit should weigh on the euro in the near and medium term," said Camilla Sutton, chief currency strategist at Scotia Capital in Toronto. "We hold a year-end euro target of $1.30 and expect it to trend lower in the near-term."

Karen Jones, technical analyst at Commerzbank, said support for the euro/dollar lies around the 2011 uptrend at $1.3212. A break below that level could trigger losses toward the October low near $1.3145, followed by $1.2860, the 2011 low.


Against the yen, the dollar slipped 0.2 percent to 77.52 yen and was down 0.6 percent this week.

The Fed's policy-setting Federal Open Market Committee meets on Tuesday and looks set to hold off on easing U.S. monetary policy for a second meeting as it gauges the impact of Europe's crisis on the economy and ponders additional steps in making its policy more transparent.

"The U.S. numbers have been somewhat better than expected, so there's no urgency for further policy easing," said Vassili Serebriakov, currency strategist at Wells Fargo in New York.

An index of consumer sentiment rose to its highest in six months in early December and the trade deficit narrowed in October, data showed on Friday, a sign the U.S. economy's health is slowly improving.

The data buoyed the euro, which has tended to benefit from stronger investor appetite for risk. But Serebriakov said that link could start to fade as the ECB eases policy further.

"There's a high chance that this pattern will break next year, so the euro will start behaving more as a funding currency as opposed to a pro-risk currency," he said. That means an increase in risk sentiment could see the euro weaken against a broad range of currencies including the U.S. dollar, commodity and emerging market currencies.

[Source: By Wanfeng Zhou, Reuters, New York, 09Dec11]

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