By Ron Harui and Stanley White
Feb. 2 (Bloomberg) — The euro fell to its lowest in almost two months against the dollar on concern a report tomorrow will show European producer prices slid for a fifth month, giving the region’s central bank more reason to cut interest rates.

Europe’s single currency declined for a third day and the British pound weakened the most in 10 days on concern policy makers in the euro area and the U.K. will lower borrowing costs as economic growth stalls. The yen rose for a third day against the dollar before a U.S. report that economists estimate will show manufacturing fell to the lowest level since 1980, adding to signs a global slowdown is worsening.

“Inflation is slowing and the euro-zone economy is deteriorating,” said Yuji Saito, head of the foreign-exchange group in Tokyo at Societe Generale SA, France’s third-largest bank by market value. “The euro is likely to be sold” to $1.2700 and 113.00 yen today, he said.

The euro dropped to $1.2732 as of 12:10 p.m. in Tokyo from $1.2813 late in New York on Jan. 30. It reached $1.2717, the weakest since Dec. 8. Europe’s single currency also fell 0.8 percent to 114.33 yen from 115.23 yen. The pound declined 1.2 percent to $1.4365 from $1.4540.

The yen rose to 89.83 per dollar from 89.92. It climbed 1.1 percent to 56.72 against Australia’s dollar and advanced 1.6 percent to 45.11 versus New Zealand’s dollar. The MSCI Asia- Pacific Index of regional shares slid 1.1 percent and theNikkei 225 Stock Average slipped 0.5 percent.

The euro weakened versus 12 of the 16 most-active currencies today. Prices of goods leaving euro-area factories fell 1.2 percent in December, after a 1.9 percent decline in November, a Bloomberg survey shows. The European Union statistics office will release the report in Luxembourg tomorrow.

‘Strongest Currency’

The odds the ECB will lower its 2 percent main rate by a quarter-percentage point at its Feb. 5 meeting were 76 percent on Jan. 30, compared with 75 percent on Jan. 29, according to a Credit Suisse Group index based on overnight swaps.

The yen also advanced for a third day versus the Australian and New Zealand dollars on speculation Japanese companies will bring home their overseas earnings before the fiscal year ends next month.

“The yen is likely to be the strongest currency for some time,” said Tsutomu Soma, a bond and currency dealer at Okasan Securities Co. in Tokyo. “There isn’t much that’s positive about the economic outlook. Investor flows back into the yen are likely to pick up pace.”

The yen may appreciate to 89.15 versus the dollar and the euro may weaken to $1.2675 today, Soma said.

VIX Volatility

The Institute for Supply Management’s factory index, due today, fell to 32.5 in January from a revised reading of 32.9 the prior month, according to a Bloomberg News survey of economists. A reading of 50 is the dividing line between growth and contraction.

Futures traders increased bets the yen will strengthen against the dollar, figures from the Washington-based Commodity Futures Trading Commission show.

The difference in the number of wagers by hedge funds and other large speculators on an advance in the yen compared with those on a drop — so-called net longs — was 49,007 on Jan. 27, compared with net longs of 47,090 a week earlier.

The VIX volatility index, a Chicago Board Options Exchange gauge reflecting expectations for stock-market price changes that is used as a measure of risk aversion, rose 5.2 percent to 44.84 on Jan. 30.

“Japanese investors tend to repatriate capital during periods of heightened risk aversion,” said Joseph Capurso, a currency strategist at Commonwealth Bank of Australia in Sydney. “The yen could retest the record high of 55 against Australia’s dollar this week.”

‘Most Critical Problem’

The Reserve Bank of Australia will cut its benchmark interest rate by 1 percentage point to 3.25 percent at a meeting tomorrow, the lowest level since 1964, according to a Bloomberg survey of economists.

Gains in the yen may be limited by speculation Japanese exporters will lobby the government to intervene by weakening the currency to protect overseas earnings.

“The yen is the most critical problem for exporters,” Masakazu Kubota, a managing director at Keidanren, Japan’s largest business lobby, said in an interview in Tokyo on Jan. 30. “Whether the government does it alone or in cooperation with others, they should do something about the yen,” he said. “Industry is crying out for it.”

Companies from Hitachi Ltd. to NEC Corp. are forecasting losses and firing workers, worsening a downturn the central bank forecasts will be the sharpest in the postwar era.

‘Potentially Significant’

Policy makers intervene by buying or selling currencies to influence exchange rates. The last time Japanese policy makers intervened, they sold a record 20.4 trillion yen ($227 billion) in 2003 and 14.8 trillion yen in the first quarter of 2004, when the yen rose as high as 103.42 per dollar.

The pound fell against the dollar for the first time in more than a week on speculation the Bank of England will trim borrowing costs to combat a recession.

Barclays Plc, which turned down government funding last year, had its long-term debt rating downgraded to Aa3 from Aa1 by Moody’s Investors Service yesterday. The rating agency cited “potentially significant further losses at Barclays as a result of writedowns on credit market exposures as well as an increase in impairments in the U.K.”

“Traders are looking for the chance to sell the pound,” said Saburo Matsumoto, senior manager in Tokyo of foreign- exchange sales at Sumitomo Trust & Banking Co., Japan’s fifth- largest bank by market value. “There are doubts about the health of the U.K. financial system. There’s no denying that U.K. rates are headed lower.”

Sterling may decline to $1.40 in the next few days, he said.

The U.K. central bank will reduce rates by half a percentage point to 1 percent when it announces a policy decision on Feb. 5, according to a separate Bloomberg survey.

To contact the reporter on this story: Ron Harui in Singapore atrharui@bloomberg.net; Stanley White in Tokyo atswhite28@bloomberg.net.

Last Updated: February 1, 2009 22:34 EST

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