The dollar dropped to a record low against the euro yesterday as fears over the US economy raised expectations that the Federal Reserve would move to lower US interest rates next week.

The prospect of a cut in US rates has reduced the attractiveness of the dollar, pushing it lower against the euro for the past seven trading sessions.

The US currency has now fallen more than 2 per cent against the euro in the last week, dropping to a low of $1.3910 against the single currency, breaching the previous record low of $1.3852 it hit on July 24.

Meanwhile, the dollar index, which tracks its value against a basket of six leading currencies, fell to 79.404, its lowest level since September 1992.

The dollar had been benefiting from the recent turbulence in financial markets as US investors repatriated funds in the face of rising risk aversion. But that trend stopped as weak economic data saw the focus of the currency markets switch to the challenges faced by the US economy.

“In the past, the dollar has been a clear beneficiary of rising risk aversion but this has been dependent on it being a global phenomenon rather than a US problem,” said Mitul Kotecha, head of global foreign exchange research at Calyon. “Over recent days, the problem has shifted back to being US-centric as it increasingly appears the US economy will suffer more than elsewhere.”

Last Friday’s US payrolls report was the catalyst for the change in mood. It revealed the first drop in US employment in four years – evidence that problems in the country’s mortgage market were spilling over into the wider economy. Markets then moved to price in a cut in interest rates from the Fed at its meeting on September 18.

In contrast, the European Central Bank signalled at its policy meeting last week that it was maintaining its monetary tightening bias and was ready to raise eurozone interest rates once stability returned to world markets.

“European officials, while acknowledging the lack of visibility at the present time, seem confident that, if the US sneezes, they won’t catch pneumonia,” said Marc Chandler, of Brown Brothers Harriman.

The lack of liquidity on the world’s lending markets has also increased the probability that the Fed will cut interest rates to stop the US economy from slipping into recession. Analysts said the longer that reluctance to lend persisted, the greater the impact.

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