By Sumeet Desai
LONDON, Nov 5 - The euro hit one-week lows against the dollar and the yen on Monday after remarks by Bundesbank President Ernst Welteke at the weekend raised speculation the European Central Bank may not cut interest rates this week.
Uncertainty surrounding the ECB policy outlook contrasted sharply with investors being very confident that the U.S. Federal Reserve would deliver a growth-boosting interest rate cut on Tuesday after the dismal data there last week.
A poll last week showed 49 out of 51 analysts thought the ECB would ease policy this Thursday but Welteke damped hopes of an easing, saying interest rate levels were already at historic lows.
The euro was also under pressure after a report which said that some euro zone countries could be masking the size of their budget deficits and that one member state, which it did not name, might have used just such a fudge in the run-up to monetary union.
"The euro's been undermined by a report that euroland governments could have temporarily reduced budget deficits to qualify for entry. Investors are also concerned that the ECB may not come through with an interest rate cut on Thursday," said Ryan Shea, senior international economist at BankOne.
By 1226 GMT the euro shed more than three-quarters of a percent against the dollar to hit $0.8950 for the first time in a week. Against the yen, it also sagged to 109.10 , down half a percent from Friday.
The euro zone inflation rate fell back to 2.4 percent in October from 2.5 percent in September. The preliminary data was in line with expectations but some investors were disappointed that the inflation rate had not fallen further toward the ECB's two percent ceiling.
"The market is unhappy with the fact the ECB is proving rather hawkish," Shahab Jalinoos, currency strategist at UBS Warburg said.
"What the market wants is an aggressive stance from the ECB to counteract the global slowdown. But inflation remained above two percent, this means the ECB will remain hawkish."
Earlier, ECB board member Eugenio Domingo Solans said the euro zone outlook for inflation would improve as the economy slowed and interest rates would respond accordingly.
FAITH IN FED
In contrast to the markets' suspicion about the wisdom of ECB decisions, investor faith that the U.S. Federal Reserve would again cut key rates to boost the world's biggest economy underpinned the dollar despite a run of dismal U.S. data last week.
"The response to the economic slowdown in the U.S. has been far more convincing and credible than the eurozone, which enhanced expectations in returns from the U.S. asset markets in the medium term," said Joe Prendergast, head of global currency strategy and research at Credit Suisse First Boston.
"That is keeping capital flows into the U.S. fairly strong, supporting the dollar."
A poll conducted on Friday showed 15 of 24 primary dealers of U.S. government securities bet on a half a point cut. That would bring the fed funds rate to 2.0 percent, its lowest level in four decades.
EURO FAILS TO INSPIRE TRUST
Analysts said the market will be watching for any comments by ECB President Wim Duisenberg later on Monday when he attends a meeting of eurozone finance ministers.
"We're expecting more pressure on the euro. The comments by Welteke have been interpreted as hawkish and that creates a level of ambiguity," said Mitul Kotecha, head of global foreign exchange research at Credit Agricole Indosuez.
The ECB has cut rates by 100 basis points so far this year, compared with the Fed's 400 points. Some analysts argue the ECB may be reluctant to act as it may fear being seen as bowing to pressure from eurozone politicians.
International Monetary Fund Managing Director Horst Koehler said on Saturday he was convinced the ECB had scope to act.
The report suggesting countries may be fudging the rules governing budget deficits added to the perception that policy was not being set correctly over the euro zone.
Professor Gustavo Piga of Italy's University of Macerata said he believed at least one euro-zone government had already used swaps to mask the true extent of its deficit. He did not name the country but newspaper reports said Italy had issued debt which matched the terms of one such arrangement.
Under current EU rules, governments do not have to disclose the use of swaps as private banks do.
Piga said they can therefore issue bonds in low interest rate currencies such as the yen without declaring the cost of swapping the proceeds back to their domestic currencies.
As they only have to declare the original coupon rate as debt, their borrowing appears lower than it really is.