December 10, 2013 / 10:09 AM / 4 years ago

Euro scales heights, stocks lose grip on gains

An electronic information board is seen at the London Stock Exchange in the City of London October 11, 2013. REUTERS/Stefan Wermuth

LONDON (Reuters) - The euro reached a five-year peak against the yen and a six-week high against the dollar on Tuesday, as focus grew on the dwindling spare cash in euro zone banks and the ECB’s apparent lack of concern.

Stocks consolidated some of their gains of the past two days as caution took over before the Federal Reserve’s meeting next week, amid talk of by some of its policymakers of scaling back its stimulus program.

Wall Street was expected to see another quiet day after the S&P 500 .SPX reached its latest record on Monday.

That was the story for Asian and European stock markets. Germany’s DAX .GDAXI, France’s CAC 40 .FCHI and Britain’s FTSE 100 .FTSE all began to sag after some mid-morning efforts to rise. .EU

Slightly weaker-than-expected French industrial production had got the day off to a shaky start. Then the equivalent report from Italy and a small upward revision to its third-quarter GDP number lifted spirits.

That kept the euro healthy at $1.3745 after it hit its highest against the dollar since late October overnight, as well as a five-year peak against the yen.

“It is hard to say the euro will weaken unless the ECB does something,” said Laurent Fransolet, an interest rate strategist at Barclays in London. “The bar for them (to carry out quantitative easing or other types of aggressive easing measures) is quite a bit higher compared to the Fed or Bank of England.”

MONEY‘S TIGHT

One factor driving the euro higher is the ECB’s balance sheet. In sharp contrast to the Fed‘s, it has shrunk 8 percent this year as banks started paying back the 1 trillion euros in financing they got at the peak of the euro crisis.

After the ECB kept rates on hold last week, the bank’s head, Mario Draghi, said he was satisfied with levels in the money markets. On Tuesday, one of its other top policymakers, Benoit Coeure, stressed the hurdles to further aggressive easing.

“I don’t see need to use spectacular measures, such as U.S.-style large-scale asset purchases,” Coeure said. He added there would have to be a lot more strings attached if the ECB ever decided to lend banks more cheap cash.

Demonstrating exactly how tight things have become in the money market, banks borrowed an extra 11 billion euros from the ECB on Tuesday, and it only just managed to get enough back to offset its controversial sovereign bond purchases of the past.

Excess ECB cash, which has long kept bank-to-bank borrowing rates pinned down, is down to its lowest level since late 2011. Banks now must pay more in the market to get funding, and for the first time since 2008 they face a premium if they want to swap dollar rate payments into euros rather than the other way around.

FED FOCUS

Euro zone government bonds were unaffected, however. The ticked down along with U.S. Treasury yields, reaching 2.8188 percent in the first flurry of U.S. trade.

The premium that investors demand to buy Italian or Spanish government bonds rather than ultra-safe German paper also fell to new lows.

Signs of improvement in the global economy have provided fitful support to riskier assets in recent weeks, amid uncertainty over the Fed’s plans for tapering off its stimulus.

A new Reuters poll showed the U.S. central bank was still expected to start the process in March, but some economists now say that it might do so as early as this month.

Several Fed officials had lent credence to the idea that a tentative reduction could come soon. St. Louis Fed President James Bullard said on Monday it might slightly reduce its bond purchases this month. Dallas Federal Reserve Bank President Richard Fisher called for tapering to start “soon.”

In emerging markets, political upheaval in Ukraine and in Thailand continued to dominate attention. But broadly positive data in China, Turkey and South Africa reinforced the picture of a global economic pickup. <EMRG/FRX>

On the commodities front, Brent oil was back below $111 a barrel. U.S. crude edged above $98 per barrel on expectations of a second weekly drop in U.S. crude inventories.

Spot gold was just below $1,250 an ounce after gaining over the past two sessions. The softer dollar helped copper touch its highest level in a month at is climbed to 7,160.75 a ton.

Additional reporting by Emelia Sithole-Matarise; Editing by Larry King

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