By Jamie McGee and Kim-Mai Cutler Dec. 16 (Bloomberg) -- The dollar fell to a two-month low against the euro on speculation the Federal Reserve will cut the target lending rate to near zero today. The U.S. currency also approached the lowest level in 13 years against the yen as the central bank considered deploying its balance sheet as the key tool for monetary policy. European Central Bank President Jean-Claude Trichet said there’s a limit to how far the bank can cut borrowing costs and signaled it may pause in January. “People are nervous the Fed will conduct a major policy easing and it will further erode the differential between euro rates and U.S. rates,” said Jessica Hoversen, a foreign- exchange and fixed-income analyst at MF Global Ltd. in Chicago. “The interest-rate differential is supportive to the euro- dollar.” The dollar slid 0.3 percent to $1.3734 per euro at 9:03 a.m. in New York, from $1.3688 yesterday. It touched $1.3744, the weakest level since Oct. 14. The U.S. currency decreased 0.9 percent to 89.83 yen from 90.65. It reached 88.53 yen on Dec. 12, the lowest level since August 1995. The euro dropped 0.6 percent to 123.38 yen from 124.09. Futures on the Chicago Board of Trade showed a 66 percent chance the Fed will trim its 1 percent target rate for overnight lending between banks to 0.25 percent, the lowest level on record, compared with no likelihood a month ago. The balance of bets is for a reduction of a half-percentage point. ‘Second Arrow’ Fed Chairman Ben S. Bernanke indicated in a Dec. 1 speech that policy makers will need to focus on “the second arrow in the central bank’s quiver -- the provision of liquidity,” including options such as purchasing Treasuries to inject more cash into the economy. “You can’t argue you should have a stronger dollar,” said David Bloom, global head of currency strategy at HSBC Holdings Plc, in an interview on Bloomberg Television. “We’re talking about a trillion-dollar stimulus, we’re talking about zero interest rates, we’re talking about quantitative easing.” The dollar remained lower versus the yen after the U.S. Commerce Department reported today in Washington that construction starts on housing fell last month to an annual rate of 625,000, the lowest level since the government started compiling statistics in 1959. Consumer prices dropped 1.7 percent in November, the most since record-keeping began in 1947, the Labor Department said. Excluding food and energy, so-called core prices were unchanged from a month earlier. European Factories The euro fell earlier against the dollar as reports showed European manufacturing and service industries contracted this month at the fastest pace in at least a decade. A composite index of factory and non-factory industries dropped in December to 38.3, the lowest level since a survey began in 1998, from 38.9 last month. The index is based on a survey of purchasing managers by Markit Economics in London. A reading below 50 indicates contraction. The ECB lowered its main refinancing rate three times since October to 2.5 percent to contain fallout from the global financial crisis. “Do we have a feeling there is a limit to the decrease in rates? At this stage certainly yes,” Trichet told journalists in Frankfurt late yesterday. Asked whether the bank will refrain from a further rate reduction next month, he said policy makers want to “concentrate at this stage on getting what we already decided to be really operational.” The U.S. currency gained 6.5 percent versus the euro and 30 percent against the pound this year on short-term funding pressure and demand for the greenback as a haven. “The dollar had a big strong rally for several months,” said Jim Rogers, chairman of Singapore-based Rogers Holdings, in an interview on Bloomberg Radio. “It was an artificial rally, in my view. It was caused by everybody being forced to reverse their positions.” The three-month cost of borrowing in dollars, or London interbank offered rate, fell to the lowest in more than four years today at 1.85 percent. To contact the reporters on this story: Jamie McGee in New York at jmcgee8@bloomberg.net; Kim-Mai Cutler in London at kcutler@bloomberg.net

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