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Euro falls after ECB’s 3rd money market operation

Having taken the lead among global central banks last week in pumping funds into the global banking system to stave off a short-term liquidity squeeze, the ECB acted again on Monday.

It injected 47.67 billion euros into the euro-zone money markets in a one day tender on Monday to replace Friday’s special three-day tender for 61.05 billion euros.

These operations helped calm financial markets rattled by spreading jitters about big bank and fund losses emanating from distress in the US subprime mortgage market.

They had the effect of weakening the euro as the additional liquidity was used to buy dollars, analysts said.

“The euro has come under pressure as the liquidity (from the tenders) flows into the US market,” said Michael Klawitter, currency strategist at Dresdner Kleinwort in Frankfurt.

High yielding currencies such as the pound and New Zealand dollar also continued a weak run as nervous investors unwound carry trades where low-yielding currencies have been sold to fund purchases of higher yielding assets.

“Risk aversion is deeply entrenched as the unfolding events in the structured credit and subprime markets spill over into the real economy, which has hit high-yielders,” Klawitter said.

At 1008 GMT the euro was down a third of a percent on the day against the dollar at $1.3645.

The euro was down 0.8 percent against the yen at 160.85 yen , approaching a four-month low around 160 yen hit on Friday.

The dollar slipped 0.4 percent against the yen to 117.86 yen , holding off the four-month low of 117.19 yen hit on electronic trading platform EBS last week.

Sterling was down 0.7 percent versus the dollar to $2.0095, its lowest level in five weeks. The New Zealand dollar was down 1.2 percent to $0.7376.

Rate expectations shift

Until liquidity fears really started to grip markets last week investors were convinced the ECB was on track to raise rates to 4.25 percent next month.

These expectations fell below 50-50 on Friday, however, and on Monday were back up around 60 percent.

While the euro slipped on news of the ECB’s latest liquidity injection and global equity markets staged a short-term recovery from last week’s turbulence, financial market participants remained on edge.

Concern of short-term liquidity drying up supported the yen as investors have cut short positions in the low-yielding Japanese currency, which has been widely used by speculators as a cheap source of funds to buy higher-yielding currencies in risky carry trades.

“Given continued uncertainty in markets, we see near-term upside risks for funding currencies (yen and Swiss franc) and anticipate the dollar will be supported versus high-yielders to the extent this remains a liquidity event,” wrtote JP Morgan currency analysts in a research note on Monday.

“More generally, however, we believe dollar remains vulnerable to market developments in part due to broader financing issues.”

Fed funds futures are pricing in around a 50-50 chance of an inter-meeting US rate cut, and a near 100-percent probability of the Fed easing at its September 18 policy meeting.

On the data front, the July US retail sales report is due at 1230 GMT.

The market brushed off data showing Japan’s economy expanded at a pace of 0.1 percent in the second quarter from the previous quarter, slightly below expectations. A slowdown had been widely expected after two quarters of robust growth.