Euro Drops On Merkel Rumor

A wave of risk aversion swept through currency markets Friday pushing the dollar and the yen higher and knocking the euro sharply lower.

The euro sank to $1.4394 from $1.4504 and to 130.57 yen from 131.93 yen. The dollar recently traded at 90.71 yen from 91.09 yen late Thursday in New York, according to EBS. The dollar was also up at 1.0268 Swiss francs from 1.0182 francs, while the pound fell to $1.6282 from $1.6335.

The decline in sentiment began in New York Thursday when retail-sales data for December failed to live up to expectations and renewed concern about the health of the economic recovery.

Markets had already turned jittery after European Central Bank President Jean-Claude Trichet made it clear earlier Thursday that the central bank isn't about to help Greece with its debt problems. Mr. Trichet told a press conference after the latest ECB policy meeting that the bank isn't going to give "special treatment" to any single country that finds itself in trouble.

This once again raised the specter of a Greek default, which pushed up the cost of insuring Greek debt through credit derivatives even further.

The mood of the market only deteriorated further after an unsubstantiated rumor circulated that German Chancellor Angela Merkel could resign. An official denial from Berlin still failed to help the euro, which by then was also suffering from a report from the World Economic Forum warning that there is a one-in-five chance of another asset price bubble implosion that could cost the world economy another $1 trillion.

By the time European trading got underway, the single currency was lower across the board with the yen rising even against the dollar as investors sought a safe haven.

Market participants are now expected to focus on a stream of fresh economic data from the U.S. later in the day as well as the start of the U.S. bank earnings season.

Some analysts reckon that the dollar could be at risk if the latest Empire State survey fails to show a rebound in manufacturing activity this month after a sharp decline last month. The consensus forecast is for the main index to have risen to 12.8 from 2.55. Others expect strong earnings from J.P. Morgan and Merrill Lynch to boost optimism about the recovery and an end to the credit crunch.

In either case, however, the actual reaction in currency markets could be muted as investors square their books ahead of a long holiday weekend in the U.S.