The euro fell 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. After a big gain on Monday, the euro had added another 0.3 percent to hit $1.2476 in early European trading, less than a cent off the three-year highs it 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. The single currency declined 0.3 percent to $1.2405 by 1105 GMT.
The dollar, measured against a basket of currencies, used the euro's weakness to rally 0.4 percent to 89.424, bouncing 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's Frankfurt-based 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 US 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. Valentin Marinov, head of G10 FX strategy at Credit Agricole, said that reduced trade fears had allowed investors to re-focus on when the ECB would tighten monetary policy, and for large institutional investors to resume allocations 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 ECB'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 as trade war worries abated.
The yen fell 0.3 percent to 105.74 yen versus the dollar, giving up some of its large gains last week when investors had fretted about trade tensions.
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