Dollar slides on speculation Fed will cut rates

The dollar declined to its weakest in three weeks against the euro. The dollar slid against all 16 of the most actively traded currencies before a report this week which may show that manufacturing growth stagnated in the world's largest economy.

On speculation the Federal Reserve will reduce interest rates this year while European Central Bank policy makers will increase their benchmark.

The Fed has held borrowing costs steady since June after a two-year campaign of raising them. ECB council member Erkki Liikanen suggested in an interview broadcast on Tuesday that rates will rise in Europe.

"We've still got an ECB that's talking in incredibly hawkish terms," Simon Derrick, chief currency strategist at the Bank of New York, said in London. The comments contrast with the trend for US rates, which is weakening the dollar, he said.

The currency fell to $1.3272 versus the euro in London, from $1.3201 in New York late on Monday, its biggest daily drop since Dec. 19. It earlier touched $1.3290, the weakest since December 12.

The US currency fell to yen 118.83 from 119.05. The dollar fell 10.2 per cent against the euro last year. A report from the Institute for Supply Management tomorrow will probably show US manufacturing didn't expand last month, after contracting for the first time since April 2003.

The survey may show a reading of 50, the dividing line between expansion and contraction, for December, compared with 49.5 in November, according to a Bloomberg News survey of economists.

"The Fed will cut interest rates and the US rate advantage will erode, weighing on the dollar,'' said Harvinder Kalirai, head of research in Sydney at State Street Corp.

The Fed has kept its overnight lending rate unchanged at 5.25 percent at its past four meetings, ending a two-year cycle of borrowing-cost increases.

Interest-rate futures indicate the odds of a quarter-percentage-point rate cut by March were 17 per cent on December 29, up from 11 per cent on December 15. US economic expansion slowed to 2 per cent in the third quarter, and 2.6 percent in the second quarter.

The yield premium investors earn on benchmark two-year US bonds over similar-maturity German bunds narrowed to 0.885 percentage points on Tuesday from 0.905 percentage points on December 29.

Employers in the US added 115,000 workers to their payrolls in December, ending a quarter in which job creation was the slowest in three years, according to the median estimate of economists surveyed by Bloomberg before the Jan. 5 report.

The economy created 132,000 jobs the previous month. The euro extended its gains on Tuesday after the ECB's Liikanen said in an interview with broadcaster YLE that wage demands in Germany may spark inflationary pressure. Policy makers lifted their benchmark refinancing rate by a quarter percentage point to 3.5 per cent on December 7.

"The ECB look like they'll keep pushing up rates," said Matthew Jones, a senior currency dealer at Custom House Global Foreign Exchange in Sydney. Growth in the euro region was 2.7 per cent in the third quarter and 2.8 percent in the second.

The Eurostat in Luxembourg releases the final estimate of third-quarter GDP next week. The euro earlier rose to a record against the yen before reports that may add to signs the European Central Bank will raise rates faster than the Bank of Japan.