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By Anirban Nag
LONDON, (Reuters) - The euro fell to a four-month low against the dollar after the European Central Bank cut interest rates, as expected, and said it would announce further policy easing measures to tackle the threat of disinflation.
The ECB cut the deposit rate to -0.10 percent, the main refinancing rate to 0.15 percent, and the marginal lending rate - or emergency borrowing rate - to 0.40 percent. Markets now turn their attention to ECB President Mario Draghi's press conference at 1230 GMT.
The ECB was widely expected to cut interest rates by 10-15 basis points, sending the deposit rate into negative territory for the first time and injecting liquidity into the banking system. The market is also expecting the ECB to offer longer-term loans in a bid to boost lending, without launching large-scale asset purchases as the Bank of Japan has done.
Many see that as the first step towards quantitative easing by the ECB, prompting speculators and investors to build up large bets against the euro. Traders said if the ECB falls short of expectations, the euro could bounce.
"After those rate cut decisions, the market is anticipating further measures like stopping its sterilization program which will inject liquidity. Investors are also expecting it to announce asset purchases," said Alvin Tan, currency strategist at Societe Generale.
"What will keep the euro down is an asset purchase program."
The euro fell to $1.3557, its lowest level since early February, on trading platform EBS. It has shed 3.1 percent from highs near $1.4000 after Draghi on May 8 prepared the market for possible policy action at the June review.
Reflecting the nervousness over ECB action or lack thereof, overnight euro/dollar implied vols jumped to 22.30 percent from around 4.6 percent at the start of the week. The one-month implied euro/dollar volatilities a gauge of how sharp swings are likely to be - held near four-month highs, trading at 6.75 percent on Thursday.
Morgan Stanley analysts reckon the imposition of negative rates could lead to an exodus from euro zone money markets. They expect U.S. money market funds, who have holdings of around 350 billion euros in the euro zone, to liquidate some of their holdings, putting downward pressure on the euro.
RATE DIFFERENTIALS FAVOR DOLLAR
Expectations of ECB action have driven German bond yields lower, giving the dollar a bigger rate advantage. U.S. two-year Treasuries US2TY=RR now offer the biggest premium over their German counterparts in almost seven years.
The dollar index hit a four-month high of 80.786.
The yen, meanwhile, appeared to be stabilizing after falling in the past few sessions. The dollar eased 0.2 percent to about 102.55 yen, down slightly from a one-month high of 102.80 yen set on Wednesday. The euro was down 0.4 percent at 139.10 yen.
News this week that Japan's Dai-ichi Life Insurance Co 8750.T has agreed to buy U.S. peer Protective Life PL.N for $5.7 billion, in the largest acquisition by a Japanese insurer, also held the attention of traders.
(Editing by Hugh Lawson/Ruth Pitchford)