The euro climbed for a fourth straight session against the dollar on Friday, underpinned by expectations that central banks around the world will act to prevent any fallout arising after Sunday's crucial Greek election. The dollar, meanwhile, slumped against the yen as Friday's US economic data reflected weakness in the recovery, raising the prospect the Federal Reserve may resort to further monetary easing.
--- Central banks' liquidity pledge reassures investors
--- Soft US data keeps speculation of Fed easing alive
--- Options reflect high level of euro uncertainty
--- Yen gains broadly after BoJ stands pat
The Federal Open Market Committee, the Fed's policy-making arm, is scheduled to meet next Tuesday and Wednesday. But Sunday's Greek vote has been the focus this week. Central banks around the world are bracing for action to counter any turmoil from Greece's election, with the European Central Bank hinting at an interest rate cut and Britain set to open its coffers.
"My main thesis continues to be that policy makers will step in to mitigate downside equity and financial market contagion risks," said Andy Busch, global currency and public policy strategist at BMO Capital Markets in Chicago. "This is precisely what has happened over the last two days and will certainly continue into next week."
A co-ordinated action is likely to support risk appetite and provide relief to the euro, although any bounce could prove temporary given Spain's elevated borrowing costs and the risk of the debt crisis spreading to Italy, the euro zone's third-largest economy. In late afternoon trading, the euro last traded at$1.2655, up 0.2 percent on the day but below a three-week high of $1.2672 hit on Monday, struck after a 100-billion-euro aid package was agreed to for Spanish banks.
The trend momentum on the euro has turned bullish the last few days, TD Securities said in a note, so further gains cannot be ruled out. The bank, however, viewed the euro's bounce in June as corrective and if the $1.2650-$1.2670 resistance holds, it expects a re-test of $1.25 early next week.
"Leading into Sunday's Greek election, some traders covered short positions, but others appear to be building longs on the belief that regardless of the outcome there is more downside than upside priced in, leaving the scales unbalanced in favour of short-term long euro positioning," said Camilla Sutton, chief currency strategist, at Scotia Capital in Toronto.
Traders said the euro has scope to post short-term gains if Greece's pro-bailout parties manage to win a majority in Sunday's election. In a scenario where the far-left anti-bailout parties win, the euro could drop toward near two-year lows of $1.2286 struck this month.
For the week, however, the euro was little changed. Investors this week slashed hefty bearish positions after hitting record highs last week. As a result, the long dollar position fell for the first time in six weeks to around $38 billion, according to Reuters data.
Uncertainty about the euro was reflected in the options market, where both one-week and one-month implied volatilities traded at elevated levels of 14.85 percent and 12.35 respectively. Spanish and Italian bond yields eased on Friday but remained near levels considered unsustainable to borrow from capital markets. The deteriorating situation in the euro zone has galvanised policymakers to consider taking action ahead of a G20 summit next week.
In the United States, data on manufacturing output showed a decline in May for the second time in three months, while a gauge of factory activity in New York state plunged this month, worrisome signs the American economy is cooling. Separate data showed US consumer sentiment falling to a six-month low in early June.
"US statistics over the past two weeks have made a third quantitative easing program far more likely," said Joseph Trevisani, chief market strategist, at WorldWide Markets in Woodcliff Lake, New Jersey. "There is nothing quite as effective in devaluing the dollar as the Federal Reserve printing press."
The dollar and euro also came under pressure against the yen after the Bank of Japan announced no change in its monetary policy. Analysts said some investors may have positioned for a more dovish stance and were buying back the yen as a result. The euro dropped 0.7 percent on the day to 99.57 yen, posting weekly losses of 1.4 percent. The dollar, meanwhile, fell 0.9 percent to 78.68 yen, according to Reuters data, its worst loss since late May. On the week, the greenback was down 1.1 percent.