Euro falls on German concerns

"The dollar continues to build on recent gains after further comments from the Fed at the end of last week suggested once again that there's going to be no let-up in the hawkish stance over interest rates."

Paul Jackson, a currency dealer with CMC Group

The euro fell sharply in London yesterday against the dollar as investors scaled back expectations for far-reaching economic reform in Germany under a left-right coalition headed by Angela Merkel.

The single European currency in late-day trade was at US$1.2055 against US$1.2125 late Friday in New York.

The greenback was trading at ¥114.28 after ¥113.78 on Friday.

The euro had initially gained on news that the political stalemate in Germany was over and that Merkel would replace Chancellor Gerhard Schroeder.

But unease was generated by news that Schroeder's Social Democrats would have more Cabinet posts than Merkel's Christian Democrats, including the foreign, finance, justice and labor ministries.

As a result, doubts were raised on the market on whether the "grand coalition" between the two parties will lead to substantive reforms that would lift economic growth.

"That's quite a price for the [Christian Democrats] to pay," said Hans Redeker, global head of forex strategy at BNP Paribas.

Uncertainty over the composition of the new government has dogged the euro since the tight Sept.18 election, which led to both Schroeder and Merkel laying claim to the post of chancellor. The German political situation was one of the reasons behind the euro's fall to near three-month lows.

Underlying dollar strength has also played its part, and most analysts predict that upcoming US economic news will provide the greenback with further support.

They said the dollar, which has risen over 10 percent against the euro this year, could be buoyed further this week by US inflation and retail sales data -- although yesterday's US trade numbers will have to be overcome first.

But whatever happens on the trade front, the market is of the opinion that the US Federal Reserve remains on course to raise the cost of borrowing again at its next meeting on Nov. 1, especially after last Friday's better-than-expected US jobs data for last month.

The Fed raised its key Fed funds rate a quarter point for the 11th consecutive time last month to 3.75 percent, and indicated that the US economy was on a steady growth track despite the impact of Hurricane Katrina.

"The dollar continues to build on recent gains after further comments from the Fed at the end of last week suggested once again that there's going to be no let-up in the hawkish stance over interest rates," said Paul Jackson, currency dealer with CMC Group.

"Oil prices are also retreating and although we're still holding clear of the US$60-a-barrel level ... this starts to remove some of the pressures associated with the wider trade deficit," he said.

Elsewhere, analysts said the pound might enjoy some respite this week, especially if yesterday's trade data continues to show an improving trend and today's earnings news shows pay pressures mounting.

Sterling has suffered heavily recently from the perception that British monetary policy was set to diverge markedly from that in the US and the eurozone.

The market remains split on the prospect of another quarter point rate cut from the Bank of England next month, which would take the key repo rate down to 4.25 percent.