European shares rally, euro slides on ECB stimulus bet

By Francesco Canepa

LONDON (Reuters) - European stocks rallied and the euro fell to near a one-year low against the dollar on Monday as expectations grew that the European Central Bank would loosen policy.

ECB President Mario Draghi said late on Friday that the bank was prepared to respond with all available tools inflation in the euro zone dropped further.

Investors speculated this meant the ECB was more likely to embark on an asset-purchase programme, or quantitative easing, or adopt other stimulus measures in coming months.

Draghi's comments caused yields on most euro zone government bonds to fall to record lows and European stock markets to rise. They overshadowed the resignation of the French government and a weak German Ifo business sentiment survey.

"The key message is that Draghi stands ready for more action if needed," said Franz Wenzel, the chief strategist at AXA Investment Managers in Paris.

"Whether they're going to do quantitative easing remains to be seen, but we're fairly confident that the financial engineers at the ECB will find other tools. At this juncture, we don't exclude quantitative easing at the end of this year."

Yields on German, Spanish, Italian and Portuguese 10-year bonds all dropped to record lows. [GVD/EUR]

The euro skidded to $1.3185 in early Asian trade, its lowest since September 2013, from around $1.3246 late in New York on Friday. It was trading at $1.3202, down about 0.3 percent on the day, at 1218 GMT, amid lower than usual volumes due to a holiday in London.

A weak German business sentiment index, Ifo, also weighed on the single currency in European trade, as it reinforced concerns about Germany, the euro zone's biggest economy.

The euro zone's blue-chip Euro STOXX 50 index, however, was up 1.2 percent and U.S. index futures, up between 0.3 percent and 0.4 percent, pointed to a higher start on Wall Street.

Both Germany's DAX and France's CAC 40 gained just over 1 percent.

French Prime Minister Manuel Valls presented his government's resignation on Monday, a day after Economy Minister Arnaud Montebourg called for new economic policies, and questioned neighbour Germany's "obsession" with budgetary rigour.

Some investors said that a stronger and more unified French government might emerge, more committed to President Francois Hollande's deficit-cutting measures.

"The new government should be more unified. Hollande has shown he will not change course," said Francois Savary, chief investment officer at Swiss bank Reyl.

US RATES SEEN RISING EARLIER

In contrast to the ECB, U.S. Federal Reserve Chair Janet Yellen on Friday acknowledged the concern of some Fed officials about sustained monetary policy stimulus, although she also stressed the need to move cautiously on raising rates.

As a result, Fed funds futures fell back as the market priced in the risk of an earlier rise in interest rates. The dollar index rose to 82.563, its highest since September last year.

In commodities markets, the rising dollar pressured prices with spot gold down 0.2 percent at $1,278.65 an ounce.

Brent crude edged above $102 a barrel on Monday amid conflict in Ukraine and Libya, although ample supply limited the rebound from last week's 14-month low.

(Additional reporting by Sudip Kar-Gupta, Anirban Nag and Marius Zaharia in London; Wayne Cole in Sydney; Editing by Susan Fenton, Larry King)