May 16 (Bloomberg) -- The yen declined to a record low against the euro for a second day as signs of weaker economic growth suggest the Bank of Japan is unlikely to raise interest rates soon, spurring the so-called carry trade.
The yield advantage on German two-year notes over Japanese equivalents rose to the most in almost five years after reports showed yesterday Europe's economy grew more than expected and Japanese machinery orders fell. The yen has fallen versus 15 of the 16 most-traded currencies this year as investors borrow at Japan's 0.5 percent interest rate to seek higher returns abroad.
``There's no limit to euro-yen at the moment,'' said Ian Gunner, head of foreign-exchange research at Mellon Bank NA in London. ``The yen is going to get weaker and weaker because this yield story is still very much intact.''
The yen dropped to an all-time low of 163.86 per euro before trading at 163.81 at 7:11 a.m. in New York from 163.45 late yesterday. The currency could drop as low as 170 against the euro in the next six weeks, Gunner said. The yen also weakened to 120.45 per dollar from 120.27. The dollar was at $1.3599 per euro from $1.3591.
Japan's currency dropped for a fourth day versus the euro as the yield spread between German and Japanese two-year government bonds widened to 3.38 percentage points, the most since September 2002. The BOJ will keep rates unchanged at a two-day policy meeting starting today, according to all 49 economists surveyed by Bloomberg News.
Investors expect the ECB to raise its benchmark rate again after an increase to 4 percent in June, futures trading shows. The yield on the three-month Euribor contract for December was 4.42 percent. The contracts settle to the three-month inter-bank offered rate for the euro, which has averaged 16 basis points more than the ECB rate since the currency's start in 1999.
ECB Remarks
ECB council member Guy Quaden today said rates aren't hindering the euro-region's economic growth, De Tijd reported, citing an interview. Quaden, who is also head of the Belgian central bank, said the ECB will ``do what's necessary,'' according to the newspaper.
``The current exchange rate of the euro is less problematic than two or three years ago,'' he also said.
Council member and French central bank Chief Christian Noyer also said today in a speech in Mumbai that borrowing costs aren't slowing growth in the 13 countries that share the euro.
``It's clear we're going to get one more hike out of the ECB and, depending on what the euro does and how much more political pressure is put on, they are probably going to do two or three more,'' said Simon Derrick, chief currency strategist at Bank of New York in London. He forecasts the euro rising to 170 yen by September.
Carry Trades
The yen has fallen 16 percent against the euro in the past year as investors entered carry trades by borrowing Japan's currency to buy euro-denominated assets with higher yields.
Volatility on one-month euro-yen options stood at 6.78 percent, down from 7.20 percent a week ago. Lower volatility may encourage carry trades as it exposes bets to less currency risk.
Japan's currency two days ago fell to the lowest since 1990 against the New Zealand dollar and yesterday dropped to the weakest since 1992 against the Canadian dollar on speculation investors will increase carry trades.
New Zealand's currency last bought 88.81 yen, after reaching 89.06. Canada's dollar traded at 109.58 yen from as high as 109.82. Interest rates are 7.75 percent in New Zealand and 4.25 percent in Canada.
U.S. Housing Market
The dollar may fall for a fourth day against the euro before a report today that's forecast to show U.S. builders constructed new homes at a slower pace, suggesting the housing market may weigh on the economy. The Labor Department will say at 8:30 a.m. in Washington housing starts fell to an annual 1.48 million units in April, according to a Bloomberg News survey.
The dollar yesterday fell to an all-time low of 78.97 against the currencies of seven trading partners, according to a Fed index published on its Web site. The euro area has the heaviest weight in the index, followed by Canada, Japan, the U.K., Switzerland, Australia and Sweden.
The Fed's broad dollar index also dropped to 104.2, the lowest since July 1997. This index includes 26 currencies.
``The U.S. housing market seems not to have bottomed,'' said Shigeru Nakane, planning manager of the market trading office in Tokyo at Resona Bank Ltd., a unit of Japan's fourth-biggest lender. ``Amid the bearish sentiment, the dollar looks weak.'' The U.S. currency may fall to 119.80 yen today, he said.
Traders should place a stop-loss on a short dollar position at 120.60 yen, Nakane said. The dollar rose as high as 120.58 yen yesterday, the strongest since Feb. 27. A short is a bet on a decline.
To contact the reporter on this story: Aaron Pan in London at apan8@bloomberg.net ; David McIntyre in Sydney at dmcintyre2@bloomberg.net
Last Updated: May 16, 2007 07:19 EDT
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