By Candice Zachariahs Oct. 3 (Bloomberg) -- The Australian dollar fell by the most this week since 1985 against the U.S. currency as investors cut holdings of higher-yielding assets on speculation the global economy won't avoid a recession. New Zealand's currency dropped versus the yen this week as did its Australian counterpart as investors reduced so-called carry trades, where they borrow money in countries with low interest rates and put the money elsewhere to reap bigger returns. Asian stocks slumped this week and traders started to bet central banks in the U.S., Europe and Japan will cut interest rates. ``The Aussie has been at the mercy of firstly a risk aversion mentality and secondly good demand for U.S. dollars,'' said Paul Milton, chief foreign-exchange dealer at Societe Generale SA in Sydney. ``There's still potential for Aussie to trade lower.'' The Australian dollar fell to 77.89 U.S. cents as of 4:38 p.m. in Sydney, taking the loss to 6.3 percent from late in New York on Sept. 26. It touched 77 cents in Asian trade today, the weakest since August 2007. New Zealand's dollar weakened 3.3 percent this week to 66.33 U.S. cents from 68.60 a week ago. Against the yen, the Australian dollar declined 6.9 percent this week to 82.03 yen from 88.10 on Sept. 26. It dropped to 81 yen, the lowest since May 2005. The New Zealand currency lost 3.9 percent to 69.88 yen from 72.72. Australia's currency may fall as low as 75 U.S. cents next week as the likely passage of a U.S. $700 billion rescue package for the financial sector will drive demand for the U.S. dollar, said Milton. ``I don't think there's any good reason to buy the Aussie at the moment.'' Volatility Index The currencies fell as the VIX volatility index, a Chicago Board Options Exchange gauge reflecting expectations for stock market price changes and a barometer of risk aversion, rose to 45.26 yesterday, near the highest close since October 1998. The MSCI Asia Pacific Index of regional shares slumped 7.5 percent this week, the most since August 2007. ``We expect the New Zealand dollar to weaken further in the weeks and months ahead as the foreign exchange markets remain volatile, risk appetite low, and domestic economic weakness has shown few signs of abating,'' wrote London-based Ned Rumpeltin, a currency strategist at Morgan Stanley in a research note dated Oct. 2. Benchmark interest rates are 7 percent in Australia and 7.5 percent in New Zealand, compared with 0.5 percent in Japan and 2 percent in the U.S., luring investors to the South Pacific nations' assets. The risk in carry trades is that exchange-rate fluctuations erase profits. The Reserve Bank of Australia may reduce interest rates by 50 basis points to 6.5 percent on Oct. 7, according to the median estimate of 19 economists surveyed by Bloomberg News. Ten forecast a half-point cut and the rest 25 basis points. Bonds, Commodities The Australian and New Zealand dollars also fell as the price of gold, Australia's third most-valuable raw material export, and crude oil, its fourth, slid. Lumber, one of New Zealand's biggest export earners, plunged to a 17-year low in New York. Raw materials account for 60 percent of Australia's exports, and 70 percent of New Zealand's. Australian government bonds rose. The yield on the 10-year note fell 7 basis points, or 0.07 percentage point, to 5.285 percent, according to data compiled by Bloomberg. The price of the 5.25 percent security due March 2019 rose 0.544, or A$5.44 per A$1,000 face amount, to 99.717. New Zealand's two-year swap rate, a fixed payment made to receive floating rates, fell to 6.835 percent today from 6.87 yesterday. To contact the reporter on this story: Candice Zachariahs in Sydney at czachariahs2@bloomberg.net

Source