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Euro hurt by widening interest rate differentials

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[June 09, 2014]  By Anirban Nag

LONDON (Reuters) - The euro gave up gains to weaken against the dollar on Monday, as yield differentials between U.S. Treasuries and German Bunds widened to multi-year highs, highlighting the monetary policy divergence between the United States and the euro zone.

Amid lower-than-usual volumes due to a holiday in some parts of Europe, the dollar held gains made after upbeat U.S. jobs data on Friday. The reassuring data bolstered risk appetite and underpinned higher-yielding currencies like the Australian AUD= and New Zealand dollars NZD=.

The euro fell 0.15 percent to $1.3620 EUR=, having risen to $1.3668 earlier in the European session. It was still some distance from a four-month low of $1.3503 hit on Thursday after the European Central Bank cut its main rates to record lows, imposed a negative rate on excess cash deposited with it and announced measures to pump money into the sluggish euro zone economy, aiming to ward off the risk of deflation.

"The yield differentials are moving against the euro and for us the currency remains a sell on rallies," said Peter Kinsella, currency strategist at Commerzbank.

"The ECB is inching towards QE while the U.S. data is picking up and it's only a matter of time before the short end of the U.S. bond market starts to price that in."
 


The ECB measures have given fresh impetus to a euro zone bond rally that has driven borrowing costs in countries that were at the forefront of the debt crisis to record lows.

German Bunds DE10YT=RR also outperformed U.S. US10YT=RR and UK GB10YT=RR counterparts, driving the 10-year yield gaps to 2005 and 2010 levels respectively. The two-year T-note yield premium remained close to its highest in seven years, underpinning the U.S. dollar.

Traders said large option expiries between $1.35 and $1.37, however, would keep the euro in that range in the near term.

DOLLAR FIRM

The dollar index was up 0.1 percent at 80.50 .DXY, while the dollar was flat against the yen at 102.45 yen JPY=.

The greenback made gains on Friday after data showed U.S. non-farm payrolls increased by 217,000 last month. The report offered confirmation that the world's largest economy has snapped back from a winter slump.

Besides the robust U.S. data, analysts cited a number of other factors likely to keep the yen under pressure.

"Right now there is also less reason to buy the yen, with factors such as NISA, public pension funds and corporate M&A seen diminishing the currency's allure," said Bart Wakabayashi, head of forex at State Street in Tokyo.

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Nippon Individual Savings Account (NISA) is a new tax-break facility for Japanese retail investors introduced in January and aimed at driving massive savings into stocks and mutual funds, some of which are expected to be invested in foreign assets.

Japan's public pension fund, the world's largest, has been working to diversify its domestic bond-centric portfolio and any changes are likely to have a significant effect on flows.

A recent increase in cross-border merger and acquisition activity by Japanese companies is another factor seen pressuring the yen by raising demand for foreign currencies.

Last week, Dai-ichi Life Insurance Co 8750.T, Japan's second-largest private sector insurer, agreed to buy U.S. peer Protective Life PL.N for $5.7 billion.

There was little market reaction to a series of data out of Japan. First-quarter economic growth was revised up to 1.6 percent from a preliminary 1.5 percent and the country posted a current account surplus for a third straight month, albeit lower than expected, in April.

The Australian dollar was up 0.3 percent at $0.9361, barely reacting to the Chinese central bank's decision to cut the reserve requirements for selected banks by 50 bps.

(Editing by Richard Borsuk & Kim Coghill)

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