European Central Bank President campaign for governments to learn the lessons of the Greek fiscal crisis may provoke a transatlantic policy split that forces the euro back toward its lows of 2006.

As investors push Greece, Portugal and Ireland to deliver on plans to cut budget deficits, the withdrawal of stimulus raises the risk of and even deflation in all or parts of the 16-nation euro area. The possibility of slower expansion is prompting economists from Deutsche Bank AG to HSBC Holdings Plc to predict Trichet’s ECB will be slower than they previously anticipated in raising its from a record low of 1 percent.

Trichet’s restraint would contrast with Federal Reserve Chairman if the U.S. central banker takes the lead in tightening economic policy while lawmakers show few signs of attacking a budget gap of more than 10 percent of gross domestic product. Such different approaches across the world’s biggest economies has BlueGold Capital Management LLP predicting the euro will fall to $1.20 for the first time since March 2006, echoing a decline when the Fed last outpaced the ECB in the middle of the last decade.

“This policy divergence is one of the central pillars of my view going forward,” said managing director of hedge-fund manager BlueGold in London and a former chief currency strategist at Morgan Stanley. “It is one more reason for investors to be cautious about the euro.”

Contrasting Policies

Europe’s single currency fell 0.3 percent to $1.3515 at 8:50 a.m. in London today, taking its decline in the past four months to 10 percent, amid speculation European Union leaders will fail to agree on an aid package for Greece this week.

When the Fed last began raising interest rates, from 1 percent in June 2004, it overtook the ECB’s benchmark 2 percent by December and had increased the overnight lending rate between banks another seven times before the Frankfurt-based ECB first shifted its benchmark in the final month of 2005. That helped push the euro down 13 percent against the dollar in 2005, when it traded as low as $1.164 that November after three years of gains.

“We’re shorting the euro,” , a fund manager at Ignis Asset Management in Glasgow, which manages the equivalent of about $107 billion. “It’s impossible to see the ECB raising rates anytime soon in the current environment and certainly not before the Fed.”

Holding Pattern

Part of the reason for the ECB’s holding pattern is the growing likelihood of fiscal retrenchment. Governments have violated the EU’s deficit limit of 3 percent of gross domestic product for a third of the euro’s first decade. Now the turmoil in Greece is forcing them to consider greater fiscal discipline after investors more than doubled the they demand on Greek 10-year bonds over their German equivalents amid its struggles to cut a 12.7 percent budget gap, the most in the euro zone.

Greece has passed three packages of deficit-reduction measures this year, including cuts totaling 4.8 billion euros ($6.5 billion) announced March 3, in a bid to lop four percentage points off its budget gap this year. The between yields on 10-year Greek and German bonds jumped to as high as 396 basis points in January from as low as 132 basis points in November. The gap was 326 basis points today.

‘Unusual Fiscal Discipline’

Other countries are seeking to avoid Greece’s fate, with most pledging to satisfy the EU’s deficit rule by 2013 at the latest after the European Commission estimated the euro area’s overall gap jumped to 6.4 percent last year from 2 percent in 2008. It predicts an increase to 6.9 percent in 2010.

Spain is enacting 50 billion euros of cuts and has proposed raising the retirement age two years to 67 to pare a 10.1 percent gap, while Portugal is planning 6 billion euros of measures including asset sales to reduce an 8 percent deficit. Ireland has won plaudits for its plan to shrink an 11.7 percent shortfall by reducing public workers’ wages and some welfare payments.

“Events in Greece could trigger unusual fiscal discipline in the euro area, implying tighter policy than expected,” chief French economist at Barclays Capital in Paris, who estimates the euro-area deficit will fall to 5.8 percent of GDP next year, compared with the European Commission’s 6.5 percent estimate in November.

Reduced Forecast

Such discipline may go some way toward appeasing Trichet. He has called deficits a “potential burden” on monetary policy and said in a March 12 Bloomberg Radio interview that governments must act “with utmost energy” to convince investors they can restore sustainability.

Their budget cuts “could add further gloom to growth prospects in the near future but also plead for long-lasting accommodative monetary policy,” Boone said, predicting the ECB will keep its key rate unchanged this year.

Deutsche Bank economists last month cut their forecast to show the ECB raising its benchmark interest rate by 50 basis points in the final quarter, half what they previously predicted. Their counterparts at HSBC said yesterday they now expect the central bank to stay on hold until March 2011 rather than shift before the end of this year.

At Morgan Stanley, Chief European Economist in London is less convinced that tougher fiscal policy will be the reason the ECB waits. She argues the region’s largest economies have yet to detail how they will cut back and estimates the bloc will tighten fiscal policy by just 0.7 percentage point of GDP next year, short of the 0.9 percentage point she calculates is required to fulfill the EU targets.

Stalled Economy

The euro-area economy in the fourth quarter, when it grew 0.1 percent from the prior three months. It will require the support of easy monetary policy if governments carry out their promise to reverse stimulus, an economist at Capital Economics Ltd. in London.

While euro-area surged the most in two decades in January, held at an 11-year high of 9.9 percent and retail sales fell 0.3 percent from December.

Even if the broader economy escapes renewed recession, individual members may not be so lucky, McKeown said. Greece and Spain continued to contract 0.8 percent and respectively through the fourth quarter, while shrank by 0.2 percent after expanding 0.7 percent in the previous three months. Deflation also still poses a “real risk” to the euro area, especially in Spain, Ireland and other nations that suffered when property bubbles burst, she said.

Disaster?

“The ECB will need to keep rates very low for a long time if governments tighten,” McKeown said. “If it doesn’t, it will be disastrous for some economies.”

The outlook may differ in the U.S., with the Fed proving faster than the ECB to raise rates, said head of global economics at Societe Generale SA’s investment-banking division.

She expects the U.S. central bank will begin lifting its near-zero benchmark rate around the end of this year, increasing it to 1.25 percent in 12 months. The ECB’s main rate will still be 1 percent in a year, she said, helping to push the euro to $1.25.

“We see the U.S. leading on monetary-policy tightening,” Marcussen said.

President administration is projecting a of 10.6 percent this year and 8.3 percent next year. Even five years from now, the White House forecasts a budget gap of just below 4 percent of GDP.

‘Enormous Deficits’

Limiting progress this year are mid-term congressional elections, making it unlikely lawmakers will ask voters to pay higher taxes or accept cuts in government programs. A budget commission Obama appointed also isn’t due to release its recommendations until after the November balloting.

“If we do have substantial fiscal tightening, that could mean lower interest rates both at the short end and the long end,” Harvard University Professor said in a March 13 interview. “I wish I saw that happening in the U.S. At this point we’re still looking at these enormous deficits.”

A further decline in the euro will be welcome relief for the European economy by boosting exports, chief European economist at Jeffries Group Inc. in London. A 6 percent drop so far this year in the currency has already handed manufacturers from printing-press maker in Wuerzburg, Germany, to French carmaker an edge to sell their products in international markets.

“The euro system desperately needs a weak euro,” Owen said.

The current crisis also may ultimately spur European officials to toughen their oversight of government policies, resulting in smaller imbalances and a stronger currency union that supports the euro, BlueGold’s Jen said.

“Greece is just the right size to reveal flaws in the system and ensure they’re addressed,” Jen said. “It may be a blessing in disguise.”

Gold Gains Most in a Week as Halt in Dollar Rally Spurs Demand

Gold gained the most in a week as a halt in the dollar’s rally may increase demand for the metal as an alternative investment.

The u.s dollar index, a six-currency gauge of the greenback’s strength, fell as much as 0.4 percent after last week climbing to the highest level in almost seven months. Gold futures, which usually move inversely to the dollar, slid 5.8 percent in three sessions to a three-month low on Feb. 5.

“The dollar is down,” the owner of Quantitative Commodity Research Ltd. in Hainburg, Germany. The metal’s sudden drop last week is also “a good indicator that prices may rise,” he said.

Gold futures for April delivery rose $13.40, or 1.3 percent, to $1,066.20 an ounce on the New York Mercantile Exchange’s Comex unit. That marks the biggest gain since Feb. 1. Futures declined 2.9 percent last week, a fourth straight drop.

In London, gold for immediate delivery fell 48 cents to $1,065.82 at 7:46 p.m. local time.

Gold futures’ relative strength index, a gauge of whether a commodity or security is overbought or oversold, plunged to 40.32 from 50.08 on Feb. 3. “From a technical perspective, gold was heavily oversold,” Fertig said.

Lunar New Year

Physical buying may also support prices before China’s weeklong Lunar New Year holidays start on Feb. 14, London-based broker ODL Securities Ltd. said today in a report.

The dollar index had a third consecutive weekly gain last week as the euro fell on concern that nations such as Greece may struggle to close budget deficits. European finance ministers said at the weekend they will help ensure that Greece tackles its deficit.

“While gold’s longer-term investment credentials remain sound, the metal is temporarily caught up in the slipstream of uncertainty currently being generated,” a senior resource analyst with Mine Life Pty Ltd. in Sydney.

Eight of 16 traders, investors and analysts surveyed by Bloomberg said bullion would fall this week. Six forecast higher prices and two were neutral.

The metal should trade at $1,000 to $1,200 an ounce this year and may advance as high as $1,500 after that, chief executive officer of said today in a television interview. Fourth-quarter profit more than tripled on surging gold prices, the company said.

SPDR Holdings

Bullion held by the biggest exchange- traded fund backed by the metal, increased 1.83 metric tons to 1,106.38 tons as of Feb. 5.

Also in New York, silver futures for March delivery rose 25.5 cents, or 1.7 percent, to $15.085 an ounce. Platinum for April delivery gained $5.90, or 0.4 percent, to $1,481 an ounce. March palladium jumped $9.40, or 2.4 percent, to $407.65 an ounce.

Palladium may average about $400 this year as fundamentals for the market improve, the executive head of Anglo Platinum Ltd.’s commercial unit, said today on a conference call. The metal, used in automotive pollution-control parts, averaged about $267 last year.

Canadian Dollar Gains for Third Straight Week on Rate Bets

The Canadian dollar posted its third consecutive weekly gain amid speculation the Bank of Canada will raise interest rates before the Federal Reserve, increasing the appeal of the nation’s assets.

The loonie, as the currency is known for the image of the waterfowl on the C$1 coin, depreciated today as crude oil fell and India’s central bank unexpectedly increased interest rates. The currency earlier reached C$1.0062, the strongest level since July 23, 2008, after a Statistics Canada report showed consumer prices gained more than forecast last month.

“The market now believes that there will be a forceful move on rates sooner rather than later,” an analyst in Toronto at the online currency-trading firm Oanda Corp. The currency’s decline “will be seen as an opportunity to only add to longer-term investors’ positions.”

The Canadian dollar declined 0.3 percent to C$1.0170 in Toronto at 4:45 p.m., from C$1.0141 yesterday. One Canadian dollar buys 98.33 U.S. cents. Since March 12 the currency has appreciated 0.2 percent.

The Standard & Poor’s 500 Index today fell 0.5 percent and the S&P/TSX Composite Index dropped 0.8 percent. Crude oil fell 1.9 percent. The loonie tends to track movements in stocks and commodities.

Canada’s dollar rose to parity with the greenback in September 2007 for the first time in three decades amid booming demand for raw materials. It was last at parity on July 22, 2008, and then lost 18 percent that year as the credit crisis crushed demand for commodities.

Commodity-linked currencies such as the Canadian and Australian dollars declined after India’s central bank lifted interest rates for the first time since July 2008, stoking concern that withdrawal of economic stimulus measures may hamper global growth.

‘Markets Risk-Off’

“The reason all the markets are risk-off in general today is because the Reserve Bank of India unexpectedly tightened monetary policy,” head of market analysis at Schneider Foreign Exchange in London. “Canada is doing less well than it was vis-a-vis the dollar but it is holding its own, supported by the CPI numbers this morning and the Bank of Canada.”

The Australian dollar fell 0.5 percent against the greenback, while the New Zealand dollar, another currency tied to growth expectations, fell 0.8 percent.

Canada’s dollar surged earlier as consumer prices advanced 0.4 percent in February after a 0.3 percent increase in the prior month. The median forecast of economists in a Bloomberg News survey was for a 0.3 percent increase.

Rate Expectations

“This morning’s high-side surprise in the inflation numbers is ramping up rate hike expectations,” a Montreal-based trader of interest-rate derivatives at brokerage Le Groupe Jitney Inc.

The yield on the December 2010 bankers’ acceptances contract jumped as much as 15 basis points to 1.63 percent, the highest since Jan. 8. Money managers and hedge funds use the contracts to bet on changes in interest rates and manage their exposure. The contracts have settled at an average of 17 basis points above the central bank’s overnight rate since Bloomberg started tracking the gap in 1992.

The Bank of Canada said on March 2 that inflation and economic output have been higher than policy makers expected, signaling rate increases in coming months. Today’s data may intensify calls for tighter monetary policy.

Government Bonds

Canada’s dollar will weaken to C$1.05 by the end of the year, according to the median forecast of economists and analysts surveyed by Bloomberg News. Royal Bank of Canada, the nation’s largest lender, sees it advancing through parity by the end of June before retreating to C$1.02 by year-end.

Canada’s government bonds declined. The two-year note’s surged seven basis points, or 0.07 percentage point, to 1.64 percent. The price of the 1.5 percent security maturing in March 2012 dropped 14 cents to C$99.75.

Canada’s government bonds of one- to three-year duration have made investors 0.5 percent this year, according to a Bank of America Merrill Lynch index.

The dollar may drop against the yen

The dollar may drop against the yen on speculation currency volatility will jump as Japan’s financial markets close for a national holiday on March 22, according to Credit Agricole CIB.

“Traders may not want large positions on concerns about the spring-equinox jinx,” said Yuji Saito, director of the foreign-exchange department in Tokyo at Credit Agricole. “They’re worried there’ll be turbulence again this year.”

In 2008, the dollar on March 17 dropped more than 3 yen to a 14-year low of 95.76 yen as traders cut positions before the holiday on March 20. Last year, the greenback slid almost 3 yen on March 19, the day preceding the break.

“There are a lot of bombshells this year, such as the Greek rescue problem and China’s monetary tightening,” Saito said. The so-called ichimoku chart shows “there could be a market reversal,” he said.

The chart is showing a “twisted” cloud pattern, indicating the dollar is vulnerable, Saito said. The chart analyzes the midpoints of historic highs and lows.

The greenback dropped 0.04 percent this week to 90.52 yen as of 7:40 a.m. in London. It slid to as low as 89.76 yen yesterday, the weakest level since March 9.