(Reuters) - A release of strategic oil reserves by the International Energy Agency could eat away the euro's favorable interest rate differentials over the U.S. dollar by subduing crude prices in the near term and easing inflationary pressures.
Currencies of oil-exporting countries such as the Canadian dollar and the Norwegian crown could also suffer while the high-yielding, commodity-linked Australian dollar, if lower energy prices reduce the need for central banks that target inflation to raise interest rates.
The IEA sent oil prices tumbling late in June after announcing the release of 60 million barrels from emergency stocks - only its third such move. Hints that a further release could follow in mid-July signal it will combat high energy prices that threaten fragile global growth.
Energy makes up 9 percent of the weighting of the euro zone consumer price index basket, and any stabilization in oil prices could lead the European Central Bank to slow its monetary tightening and remove a pillar of support for the euro.
"The key reason the euro has strengthened against the dollar this year is the ECB raising rates when the Federal Reserve is not," said Julian Jessop, chief international economist at Capital Economics, who see the euro at $1.30 by end-2012.Currencies of oil-exporting countries such as the Canadian dollar and the Norwegian crown could also suffer while the high-yielding, commodity-linked Australian dollar, if lower energy prices reduce the need for central banks that target inflation to raise interest rates.
The IEA sent oil prices tumbling late in June after announcing the release of 60 million barrels from emergency stocks - only its third such move. Hints that a further release could follow in mid-July signal it will combat high energy prices that threaten fragile global growth.
Energy makes up 9 percent of the weighting of the euro zone consumer price index basket, and any stabilization in oil prices could lead the European Central Bank to slow its monetary tightening and remove a pillar of support for the euro.
"But there is a slowdown in the euro zone and slowing oil prices and if the ECB goes back on hold that kicks away that support."
The single currency was trading near a four-month low of $1.3928 versus the dollar, still up 4 percent on the year and showing some resilience in the face of a sovereign debt crisis threatening to overwhelm Greece, Ireland, Portugal and destabilize banks within the euro zone.
It has been supported by Asian central banks and Middle East sovereign investors who are increasingly diversifying their dollar assets into the euro.
These investors have glossed over many of the common currency's problems, attracted by favorable interest rate differentials. While the U.S. Federal Reserve keeps rates near zero, the ECB has already raised rates twice this year, taking its key refinancing rate to 1.5 percent as it seeks to combat inflation.
But once energy is stripped out of the euro zone's CPI basket the argument for more monetary tightening is less compelling and could temper ECB President Jean-Claude Trichet's hawkish bias on inflation.
Derek Halpenny, European head of global currency research at Bank of Tokyo-Mitsubishi, estimates euro zone consumer price inflation could fall by 0.5 to 0.6 percentage points by Q4 if Brent crude stabilizes to around $100 a barrel in Q4 this year.
"We think this rate hike will be the last this year. The energy component will come out of inflation figures a little bit faster than the ECB was anticipating," he said.
"The dollar will benefit as the market ultimately starts to remove tightening cycle expectations. Our six-month view puts the euro at $1.3500."
DOLLAR BENEFITS
The U.S. dollar's strong inverse correlation with crude prices means that if oil prices fall, even if only briefly, they could offer the greenback some support.
The 66-day rolling correlation between the dollar index, a measure of the U.S. dollar's performance against a basket of currencies, and U.S. crude was last at minus 0.51. A reading of plus 1 is a very strong correlation.
"The IEA intervention is clearly positive for the dollar," said Mansoor Mohi-uddin, head of FX strategy at UBS.
"By pushing oil prices down by several dollars a barrel even temporarily, the action will reduce the accumulation of petrodollars by oil-producing economies and thus their scope for diversifying new foreign exchange reserves into other currencies like the euro."
Lower oil prices will help oil-importing countries, most of which are fighting inflationary pressures by raising rates. Their tightening measures have threatened domestic demand and global growth prospects just as recovery in the industrialized world remains fragile at best.
The official pressure to cap oil prices and the general slowdown in runaway commodity prices are likely to weigh on growth-linked currencies along with the euro.
"If commodities go down so will the Australian dollar," said Neil Mellor, currency strategist at Bank of New York Mellon. "It's the canary in the coalmine and has gone nowhere since April."
Analysts said 60 million barrels of oil was a drop in the ocean compared with the 86 million barrels consumed daily. Brent, which dropped as low as $103 in the aftermath of the IEA announcement, is trading around pre-release levels close to $115.
But the IEA release, coupled with a pullback in a broad commodities rally in the first part of 2011 that sent Brent soaring to a 2 1/2-year high of $127 in May, has fired a warning shot across the bows of speculators.
"The IEA intervention on its own is not going to transform the outlook for oil prices but it has injected a bit of uncertainty and taken some of the speculative froth out," Jessop said.
