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Euro remains stuck near two-month low as bears await dovish ECB

* Graphic: World FX rates in 2019 http://tmsnrt.rs/2egbfVh

* Worsening data bolsters case for dovish ECB

* Sterling stable after Johnson becomes British PM

* Dollar supported before Fed meeting next week (Adds analyst quote, Australian dollar)

By Stanley White

TOKYO, July 25 (Reuters) – The euro was mired near a two-month low on Thursday before a European Central Bank meeting that could signal monetary easing as growth in the currency zone falters.

Sentiment towards the single currency took a big hit after data on Wednesday showed Germany’s manufacturing sector contracted at the fastest pace in seven years while French business growth unexpectedly slowed, sending European bond yields lower.

The Australian dollar dipped after the country’s central bank governor said policy could be eased again if needed, and that it was “reasonable” to expect interest rates to remain low for an extended period.

Investor focus in Asia remained predominantly on global central bank and political developments, particularly in Europe and the United States.

Sterling held onto gains it made after Boris Johnson became Britain’s new prime minister on Wednesday, but investors are still wary of a no-deal Brexit in which Britain would leave the European Union without a trade agreement.

The dollar found support after U.S. Treasury Secretary Steven Mnuchin said he would not advocate a weaker currency.

Investor focus shifts to the ECB’s meeting later on Thursday and a widely expected interest rate cut from the U.S. Federal Reserve next week, both of which are expected to dictate the tempo for currencies and bond yields in coming months.

“I see more downside for the euro, because there are no good signs coming from Europe at the moment,” said Tsutomu Soma, general manager of fixed income business solutions at SBI Securities in Tokyo.

“Don’t expect European bond yields to rise anytime soon. The U.S. is headed toward lower rates, which used to be a supportive factor for the euro, but that is no longer the case.”

The common currency traded at $1.11350 after touching $1.11270, its lowest since May 31.

The euro has fallen 2.0% this month on increased speculation the ECB would join other central banks in easing policy as a trade war between the United States and China weakens the global economy.

Traders see a 48% probability that European policymakers will lower a key deposit rate by 10 basis points to minus 0.50%, according to interest rate swaps.

If the ECB keeps policy on hold Thursday, economists say President Mario Draghi could flag a rate cut for the next meeting in September.

The Ifo institute will release its closely-watched index of German business sentiment later on Thursday, which will provide further clues about the health of Europe’s largest economy.

To be sure, while sentiment for the euro remains weak, some investors argue that further declines in it and European government bonds are likely to be limited.

“Europe’s economic fundamentals have worsened, but at this point most of this is already priced into the markets,” said Kiyoshi Ishigane, chief fund manager at Mitsubishi UFJ Kokusai Asset Management Co in Tokyo.

“The ECB needs to ease policy, but I don’t think European yields can fall much more. I don’t want to chase the falling euro and falling yield trade at this stage.”

Sterling was little changed at $1.2472, staging a modest recovery from a 27-month low of $1.2382 reached last week.

Johnson promised in his first speech as prime minister to lead Britain out of the EU on Oct. 31 with “no ifs or buts” and warned there would be a no-deal Brexit if the bloc refused to negotiate.

The dollar traded at 108.130 yen, near a one-week high of 108.290 yen.

Mnuchin told CNBC in an interview the United States benefits from the greenback’s standing as the world’s reserve currency.

The dollar was also supported by a White House statement that top U.S. negotiators will meet their Chinese counterparts in Shanghai starting July 30.

The world’s two-biggest economies are seeking a resolution to their bruising trade war.

The dollar index, which measures the greenback against six major currencies, stood at 97.725 after touching an eight-week high of 97.810 on Wednesday.

The Aussie slipped 0.1% to $0.6967 as Reserve Bank of Australia (RBA) Governor Philip Lowe’s outlook on keeping rates low was taken as a dovish development.

The RBA has reduced interest rates twice since June to a record low 1% to revive growth and inflation. (Reporting by Stanley White; Editing by Sam Holmes and Richard Borsuk)

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