Dollar Declines From Highest Level in Two Weeks Against Euro

By Kim-Mai Cutler and Andrew Macaskill

Oct. 1 (Bloomberg) -- The dollar fell from near a two-week high against the euro on speculation the U.S. economy will enter a recession regardless of whether Congress approves the Bush administration's $700 billion bank-bailout proposals.

The euro rebounded after posting its biggest drop in seven years against the U.S. currency yesterday as Senate Democrats and Republicans agreed to vote today on the rescue plan. The British pound declined against the euro after a report showed U.K. manufacturing contracted at its fastest pace in 16 years.

``We don't think that what we've seen over the last month is the beginning of a sustained dollar rally,'' said Martin McMahon, a Zurich-based currency strategist for Credit Suisse Group. ``There are still lots of problems for the dollar.''

The U.S. currency weakened to $1.4143 per euro at 9:42 a.m. in London, from $1.4092 yesterday in New York. It surged 2.4 percent yesterday, the most since January 2001, and reached a high of $1.4009. The dollar was also at 106.25 yen from 106.11.

Senate leaders vowed yesterday to revive a bill to buy distressed assets from banks. The legislation was rejected two days ago by the House of Representatives. The measures would give Treasury Secretary Henry Paulson broad authority to buy troubled assets from financial companies. Senators plan to include a provision that would raise the limit on federal insurance for bank deposits to $250,000 from $100,000, a move demanded by some of the rescue plan's critics.

Writedowns and Losses

Global financial institutions posted $590 billion of losses and writedowns since the start of last year following the collapse of the U.S. subprime-mortgage market. The losses led to a credit crunch that caused banks including Lehman Brothers Holdings Inc. and Washington Mutual Inc. to fail last month.

The euro's gains came a day before a meeting of the European Central Bank at which policy makers led by Jean-Claude Trichet will probably keep interest rates at 4.25 percent.

``I don't think the euro can get a lot of traction out of Trichet tomorrow,'' said Jeremy Stretch, a strategist in London at Rabobank International, the third-largest Dutch bank. ``If he is seen to be hawkish, the euro will fall and if he is seen to open the gates, I think the euro will slide on that basis as well. We are in an environment where pro-growth policies are more highly prized than anti-inflation'' policies, he said.

Banks are being squeezed amid a surge in borrowing costs as lenders hoard cash on concern more financial institutions will fail. The euro interbank offered rate, or Euribor, for one-month loans jumped to a record 5.05 percent yesterday. The London interbank offered rate, or Libor, for overnight dollar loans climbed to an all-time high of 6.88 percent.

Swap Premiums

Foreign banks are paying the highest premiums in at least a decade to borrow in dollars in the swaps market even after the Fed this week increased the amount of funds available to other central banks to $620 billion from $330 billion. The price on one-year cross-currency basis swaps between yen and dollars reached minus 70 basis points, the biggest effective premium for dollar funding since Bloomberg began tracking the data in 1997.

The pound declined versus the euro after Reuters reported the Chartered Institute of Purchasing and Supply's index of manufacturing fell to 41 in September, from 45.1 in August, the lowest since January 1992. Economists predicted 45, the median of 31 forecasts in a Bloomberg News survey showed. The reading has held below 50, signaling contraction, for five months. The U.K. currency was at 79.31 pence per euro, from 79.13 pence.

The yen fell against all 16 most actively traded currencies after the Bank of Japan's quarterly Tankan survey showed large manufacturers turned pessimistic about their prospects in September for the first time in five years. The Japanese currency weakened to 150.07 per euro, from 149.56 yesterday.

To contact the reporters on this story: Kim-Mai Cutler in London at kcutler@bloomberg.net; Andrew MacAskill in London at amacaskill@bloomberg.net

Last Updated: October 1, 2008 05:11 EDT