The dollar fell, heading for its biggest quarterly loss since 2004, as reports showing slower U.S. economic growth fueled speculation the Federal Reserve will trail the European Central Bank in lifting interest rates.

Traders sold dollars as they added to bets the Fed will pause after lifting the overnight lending rate between banks yesterday for the 17th straight time. The extra yield on U.S. two- year notes relative to German debt shrank to a three-week low.

``We are seeing a fairly clear dollar-weakening trend,'' said Jens Nordvig, a currency strategist in New York at Goldman, Sachs & Co. ``People are pricing out further interest-rate hikes in August and beyond.''

The dollar weakened to $1.2785 per euro at 11:26 a.m. in New York, from $1.2664 late yesterday, reaching the lowest since June 8. It fell to 114.32 yen, from 115.18 yen. The U.S. currency has fallen 5 percent against the euro and 2.9 percent versus the yen since March 31, the most since the last quarter of 2004.

Yields on two-year Treasury notes were 1.60 percentage points above those on similar-maturity German government bonds, the benchmark for Europe, the least since June 7.

Interest-rate futures show traders see 57 percent odds the Fed will lift the overnight lending rate between banks by a quarter-percentage point to 5.5 percent in August. Two days ago the figure was 85 percent.

``Some inflation risks remain,'' the Fed said yesterday after lifting its benchmark a 17th straight time since June 2004, to 5.25 percent. ``The extent and timing of any additional firming that may be needed to address these risks will depend on the evolution of the outlook for both inflation and economic growth.''

Shifting Psychology

Dollar losses deepened after the Commerce Department said personal spending rose 0.4 percent in May, slowing from 0.7 percent in April. The inflation gauge the Fed uses in its forecasts held at 2.1 percent. Though still above the ``comfort'' zone identified by Chairman Ben S. Bernanke, evidence inflation isn't quickening hurt the dollar, said Nordvig.

A separate report showed an index of Chicago-area business fell to 56.5 in June from 61.5 in May, according to the National Association of Supply Management-Chicago. It compared with a median forecast of 59 in a Bloomberg survey. The University of Michigan said its index of consumer confidence rose to 84.9 this month, from 79.1 in May.

``The psychology now is to sell the dollar and buy euro and other currencies,'' said Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York.

`Inch Higher'

The ECB will raise its benchmark a quarter-point to 3 percent in the next three months and then to 3.25 percent by year-end, according to the median forecast of 15 analysts surveyed by Bloomberg from June 9 to June 15.

The European Commission said confidence among the region's executives and consumers jumped to a five-year high in June.

``The ECB might have more to tighten for the rest of this year relative to the Federal Reserve,'' said Sue Trinh, a currency strategist at RBC Capital Markets in Sydney. ``We expect the euro to inch higher.''

At least six ECB policy makers this month signaled a faster pace of rate boosts in the euro region. The bank has lifted rates three times since the start of December.

ECB council members Yves Mersch and Nicholas Garganas said in interviews this week a rate boost of more than a quarter-point or a faster pace of increases are options for the bank.

JPMorgan's Call

JPMorgan Chase & Co. economists raised their prediction this week for the ECB's rate by a quarter-point to 3.75 percent by year-end. The bank also expects a boost July 6.

The euro pared gains after a report showed German retail sales fell the most in two years in May. Sales slid 2.2 percent from April, against the median forecast of a 0.3 percent decline.

Gains in the yen may be limited by concern Bank of Japan Governor Toshihiko Fukui will be forced to step down over his investment in a fund founded by Yoshiaki Murakami, who has been indicted for insider trading.

The governor has $120,000 worth of dollar-denominated deposits, according to documents he submitted to parliament on June 27, the Asahi newspaper reported today.

Shinichiro Furumoto, a member of the opposition Democratic Party of Japan, yesterday told a news conference Fukui's dollar- denominated assets may raise legal concerns, the newspaper reported.

``Fukui is under fire from many quarters,'' said Kenichiro Ikezawa, who helps oversee the equivalent of about $1 billion at Daiwa SB Investments Ltd. in Tokyo. ``This will not only harm the credibility of the Japanese financial system, but also Japan's political and economic systems. That'll continue to weigh on the yen.''

Japan's consumer prices rose at the fastest pace in eight years in May, supporting the case for the BOJ to raise rates.

Core consumer prices, which exclude fresh food, climbed 0.6 percent in May from a year earlier, gaining for a seventh month, the statistics bureau said today.

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To contact the reporter on this story:
Kabir Chibber in London at  kchibber@bloomberg.net;
Min Zeng in New York at  mzeng2@bloomberg.net.

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