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Thu 8 Dec 2011 04:03 PM

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Euro steady ahead of ECB, summit optimism wanes

Investors shuffle positions ahead of crucial EU leaders meeting on Thursday night and Friday

Euro steady ahead of ECB, summit optimism wanes
The euro has gained 1.4 percent since it hit a seven-week trough of $1.3213 on Nov 25

The euro was steady against the dollar on Thursday ahead of a widely expected interest rate cut by the European Central Bank with the focus on whether it would provide extra support to indebted euro zone countries.

Investors shuffled positions ahead of a crucial EU leaders meeting on Thursday night and Friday, with doubts already creeping in about whether politicians can agree to a comprehensive fiscal plan that will address the euro zone's two-year-old debt crisis.

The euro held flat at $1.3405, roughly in the middle of its tight $1.3332-3486 range from the past week. It got a slight lift early in the European session after Clearing houses LCH.Clearnet SA and Cassa Di Compensazione e Garanzia cut the margin requirements on Italian bonds.

It had mover higher in the Asian session after the Nikkei business daily said the G20 was preparing a $600bn lending facility for the IMF to help Europe, but the move faded after it was denied by G20 and IMF officials.

The euro has gained 1.4 percent since it hit a seven-week trough of $1.3213 on November 25, but investors are wary to build positions as many do not believe that the EU summit will provide a fix to the two-year old sovereign debt crisis.

"Some of the optimism from the summit has dissipated and I do not expect much of a surprise from the ECB either," said Jeremy Stretch, head of currency strategy at CIBC World Market.

"The euro will trade in a range of $1.3350-1.3450 with the ECB chief putting the onus on politicians to get their act together before he can provide more support in the form of buying more peripheral debt."

Money markets are fully pricing in a 25 basis point rate cut by the ECB on Thursday with the risk of more easing next year. The decision will be announced at 1245 GMT followed by a press conference by ECB president Mario Draghi.

With monetary policy already easy, markets expect the ECB to lean more towards non-standard measures like more liquidity injection and loosening of collateral eligibility.

According to Citi's index on hedge fund positioning, there has been little evidence of short covering over the past two weeks and not much substantial buying in anticipation of this week's events.

"This could soften the blow on FX if policymakers disappoint and it sets a relatively low bar for a euro-positive surprise," its strategists said in a note.

The euro could also take direction from how peripheral bonds and stock markets react to the ECB meeting. If risk appetite improves, the common currency could get a fleeting boost.

Any gains could run into more selling by investors who are still inclined to run bearish positions on the euro.

A key focal point of the summit is whether euro zone leaders make enough progress towards fiscal integration and more stringent budgetary discipline to pave the way for the ECB to take a greater role in stabilising bond markets.

Investors are hoping the summit will seek to increase the firepower of the current euro zone rescue fund and its successor, so that a credible backstop is put in place contain a debt contagion.

But a senior German official has already dampened hopes, saying Berlin is increasingly pessimistic because some governments don't seem to grasp the gravity of the situation.

Some analysts, though, suspect that Germany is trying to lower expectations so that, when there are announcements on Friday, markets will react enthusiastically.

"There has been an intense management of expectations ahead of the summit," said George Saravelos, G10 FX strategist at Deutsche Bank. "What will be crucial for markets is whether the summit will deliver enough for the ECB to act. So even if there is a lift in the euro post-ECB, most will be wary going into the summit."

The euro was down 0.4 percent against the yen at 103.71 yen and flat at 1.2381 Swiss francs.

It rose to a one-month high of around 1.2443 francs after the Swiss finance minister said authorities could consider negative interest rate and capital control options to curb the franc's strength.

The dollar fell 0.15 percent against a basket of currencies to 78.369 and dropped 0.4 percent against the yen to 77.38 yen.

Sterling was slightly higher against the dollar at $1.5784 and firm near a one-month high against the euro ahead of a rate decision by the Bank of England. The BoE is expected to hold interest rates unchanged at 0.5 percent and reaffirm a commitment to loose policy.

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