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FOREX-Euro falls as concerns about low inflation resurface

LONDON (Reuters) - The euro fell back from a five-week high on Tuesday, as concerns about weak inflation and a slowdown in company borrowing raised questions about the momentum of the euro zone’s economic expansion.

An illustration picture shows a one euro coin, April 8, 2017. REUTERS/Kai Pfaffenbach

After a big gain on Monday, the euro had added another 0.3 percent to hit $1.2473 EUR= in early European trading, leaving it less than cent off the three-year highs hit in mid-February. Receding worries about a trade war had supported euro bulls.

But it went into reverse after data showing that lending to euro zone companies slowed last month and comments by European Central Bank Governing Council member Erkki Liikanen that underlying euro zone inflation may remain lower than expected even if growth is robust.

It was down 0.2 percent at $1.2417 EUR= by 0950 GMT.

The dollar rallied 0.3 percent against a basket of currencies to 89.334 .DXY, off the five-week lows hit on Monday.

“The (euro zone) economy has been doing extremely well, but inflation is still lagging. The market has been focused on the economy, now the economy is stalling, this is adding to investors’ doubt,” said Commerzbank FX strategist Thu Lan Nguyen.

“The market is pricing in rate hikes as soon as spring next year, in our view it’s too optimistic. We assume the market will price these hikes out in the course of this year and because of that the euro will weaken.”

With many traders betting on prolonged dollar weakness this year because of the United States’ trade and budget deficits, and investors expecting to allocate more money to the euro zone as its economy strengthens, the single currency has performed well in 2018.

Global markets were shaken this month after U.S. President Donald Trump moved to impose tariffs on Chinese goods and Beijing threatened similar measures. But fears of a trade war eased on hopes that the United States and China would begin negotiations.

FILE PHOTO - Light is cast on a U.S. one-hundred dollar bill next to a Japanese 10,000 yen note in this picture illustration shot February 28, 2013. REUTERS/Shohei Miyano/Illustration/File Photo

Valentin Marinov, head of G10 FX strategy at Credit Agricole, said that the ease in trade fears had allowed investors to re-focus on whether the European Central Bank would tighten monetary policy faster than expected, and for large institutional investors to resume allocating more money to the region after years of being underweight.

“You have the fact euro zone inflation may be recovering plus the old theme of (investor) diversification back into euros,” he said, adding that for the euro to move much higher you would need to see stronger evidence the ECB will in fact shrink its balance sheet.

Comments from Jens Weidmann, Germany’s likely candidate to become the European Central Bank’s next president, that market expectations of a rate hike towards the middle of next year were “not completely unrealistic” had also helped bolster the euro on Monday.

Elsewhere, the safe haven Japanese yen sagged.

The yen fell 0.3 percent to 105.70 yen JPY= versus the dollar as the Japanese currency gave up some of its large gains last week when investors had fretted about trade tensions.

The euro rose 0.3 percent against the yen to 131.69 yen EURJPY=, after surging 1.4 percent on Monday for its biggest one-day percentage gain since June 2017.

Asian currencies such as the Korean Won and Chinese Yuan, which hit a new 2-1/2 year high, were also big winners overnight as both had been expected to fare badly if trade tensions ratcheted up.

The offshore yuan CNH=D3 strengthened to a high of 6.2364, the firmest level since Aug. 11, 2015, before falling back.

The Malaysian rinngit hit a two-month high of 3.8700 MYR= against the U.S. dollar.

Additional reporting by Masayuki Kitano in Singapore; Editing by Raissa Kasolowsky and Andrew Heavens

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