The euro dropped the most in more than five months versus the dollar after the inflation rate in the region unexpectedly cooled, fueling speculation the European Central Bank will cut interest rates to spur the recovery.

The shared currency fell against most of its 16 major peers as separate data showed unemployment in the euro area climbed to a record 12.2 percent. The yen pared its first gain in five days versus the dollar as a U.S. business barometer unexpectedly jumped. Sweden’s krona sank for a fourth day before a report tomorrow forecast to show manufacturing slowed.

“There was a big downward surprise for inflation numbers in the euro zone,” Vassili Serebriakov, a foreign-exchange strategist at BNP Paribas SA in New York, said in a phone interview. “It was a very dovish signal for the European Central Bank. Markets built up long positions in the euro too quickly.”

Eoin Treacy's view Sentiment towards the Eurozone improved steadily over the summer as first one then another country exited recession. Conversations began to focus more towards recovery and value rather than predictions of imminent disaster and the Euro rallied impressively against the Dollar from its last retest of the 200-day MA in July.

Improved perceptions of value have not masked the considerable challenges that remain for the Eurozone. The fiscal consolidation route to crisis management, which has been favoured by creditor nations within the Eurozone, has resulted in a lower growth expectation and deflationary forces across the periphery. If inflationary expectations ease further, an additional cut of 25 basis points to short-term interest rates cannot be ruled out. The Euro pulled back sharply against the Dollar and Pound today suggesting a peak of at least near-term significance.

German 10-year Bund yields have returned to test the region of the 200-day MA and the upper side of an almost yearlong base. A clear upward dynamic would confirm supply dominance in this area.

The weakness of the Dollar since July has been a tailwind for the USA’s export sector, consolidating for earnings back into the greenback. While the S&P has rallied higher in a series of short-term advances over the last six months, when redenominated into Euro it has been ranging since May. If the Dollar continues to rally, it may act to flatter the performance of US shares for foreign investors but the export sector would face a headwind.

Gold had rallied to break a short-term progression of lower rally highs earlier this month. It will now need to find support above $1250 if potential for higher to lateral ranging is to be given the benefit of the doubt.