Dollar Hits Low Against Euro as Rate Outlooks Diverge

The dollar fell to a record low against the euro on Wednesday as investors braced for the Federal Reserve to cut interest rates next week, rendering dollar-denominated assets less attractive to global investors.

Meanwhile, recent remarks from European policymakers have suggested future euro-zone rate hikes remain on the table.

The combination helped push the euro to an all-time high above $1.39 and kept it on track for its sixth straight day of gains against the U.S. currency.

Against a basket of currencies, the dollar plumbed a fresh 15-year low and it was unable to hold gains on the yen after the resignation of Japanese Prime Minister Shinzo Abe.

"It's all about lower growth, lower rate expectations now," said Gregory Salvaggio, senior currency trader at Tempus Consulting in Washington. "That combination is fueling a shift to the euro, especially ahead of the Fed's meeting next week, and now that we broke $1.39, the next one at $1.40 is within sight."

Problems in global credit markets and weak U.S. employment and housing data have increased expectations that the Fed could slash the 5.25% federal funds rate by half a percentage point at its Sept. 18 policy meeting.

But markets think the European Central Bank may raise rates again this year, provided credit turmoil recedes, after opting to keep them at 4% at a policy meeting last week.

ECB Governing Council member Victor Constancio told Reuters on Wednesday that officials are keeping all options open, and that future decisions depend on the duration and economic impact of the market turmoil.

That contributed to the euro's strength and echoed remarks from ECB President Jean-Claude Trichet, who said last week the bank would continue to watch inflation closely.

"ECB rhetoric the last couple of days has signaled they are delaying, not abandoning, a future rate hike," said Michael Malpede, senior currency strategist at Man Global Research in Chicago.

The euro last traded at $1.3905, just below a record peak at $1.3915, according to electronic trading platform EBS. It was up 0.4% at 158.70 yen. The dollar fell 0.4% to 1.1847 Swiss francs. Against the yen, it was down 0.1% at 114.15.

U.S. Growth Sputtering

Worrying signs about the health of the U.S. economy have been building since a report last week showed U.S. payrolls contracted in August for the first time in four years.

This week, the National Association of Realtors cut its housing forecasts for the seventh straight month, while U.S. Treasury Secretary Henry Paulson said on Wednesday that markets will be slow to recover from turmoil sparked by rising mortgage defaults and losses on bonds backed by risky home loans.

"The truth is that there is a serious downside risk to the U.S. economy and that, combined with lower rates, simply puts pressure on the dollar," said David Watt, currency strategist at RBC Capital in Toronto.

Oil's rise to a record above $80 a barrel boosted the commodity-sensitive Canadian dollar by 0.6% to C$1.0360 per U.S. dollar.

A rise in energy shares also lifted U.S. stock indexes and prompted investors to wade back into carry trades that borrow yen at low interest rates to buy higher-yield assets.

The yen slipped on news that Abe had stepped down but recovered as traders sold the dollar against the euro.