May 15 (Bloomberg) -- The euro fell against the dollar and extended a weekly loss versus the yen after a report showed the region’s economy shrank the most in 13 years, stoking investor concern that the pace of recovery will sputter.

The euro also headed for its first weekly decline in a month versus the dollar as the European Union’s statistics office in Luxembourg said gross domestic product among the 16 nations contracted 2.5 percent from the fourth quarter, the most since the data were first compiled in 1995. New Zealand’s dollar weakened against all 16 of the most-traded currencies as the country’s retail sales dropped almost twice as fast as economists forecast. South Korea’s won rose as overseas funds bought more local stocks than they sold.

“It’s a really bad piece of data, and it’s going to get worse because the European Central Bank has only come up with half-hearted measures” to revive growth, said Geoffrey Yu, a strategist in London at UBS AG, the world’s second-largest currency trader. “This is going to be bad for the euro.”

The euro fell to $1.3560 as of 6 a.m. in New York from $1.3639 in New York yesterday, bringing its decline this week to 0.5 percent. The common currency slid to 128.61 yen from 130.67 yen, for a 4.2 percent decline this week. The dollar dropped to 94.82 yen, from 95.80 yen.

New Zealand’s dollar fell 5.8 percent against the yen this week, the most since the five days through Jan. 16. It dropped to 55.97 yen today from 57.16 yen. The kiwi also slumped 1.2 percent to 58.97 U.S. cents, extending its decline to 2.4 percent this week. South Korea’s won advanced to 1,257.00 per dollar from 1,266.90 yesterday, paring its weekly loss to 0.8 percent.

German GDP

Germany’s gross domestic product dropped a seasonally adjusted 3.8 percent in the first quarter from the fourth quarter, when it fell 2.2 percent, the Federal Statistics Office in Wiesbaden said earlier today. That’s the deepest slump since quarterly data were first compiled in 1970 and compares with the 3 percent decline estimated by economists in a Bloomberg survey.

The yen and the dollar headed for weekly gains versus higher-yielding currencies as stock markets were poised for their first weekly loss in two months. The MSCI World Index fell 2.8 percent this week as a U.S. government report showed retail sales unexpectedly slumped and China’s exports fell more than economists had estimated, undermining speculation the worst of the international recession has passed.

“The trend for the global economy is still likely to be downward,” said Tsutomu Soma, a bond and currency dealer at Okasan Securities Co. in Tokyo. “Investors remain risk-averse. The dollar and the yen will probably be bought.”

Dollar Index

The Dollar Index, used by the ICE to track the U.S. currency versus the euro, yen, pound, Swiss franc, Canadian dollar and Swedish krona, rose to 82.592, from 82.388 yesterday and 82.529 at the end of last week.

The euro also fell this week as ECB policy makers clashed over the bank’s asset-buying program and the prospects for a recovery. Vice President Lucas Papademos said yesterday a recovery may come sooner than previously thought. Dutch council member Nout Wellink said economists shouldn’t get too optimistic. Austrian council member Ewald Nowotny said today there is “no divergence in views of central bankers.”

The ECB cut its benchmark interest rate to a record 1 percent on May 7 and announced a plan to buy 60 billion euros ($81.8 billion) in covered bonds to loosen credit markets.

‘Aggressive’ Sell-off

Global markets are ready for an “aggressive” sell-off of higher-risk assets, according to Citigroup Inc.

“Almost without exception the various markets seem to be suggesting a real danger that we are about to see a six- to eight-week period that is very risk negative,” currency strategists Tom Fitzpatrick in New York and London-based Shyam Devani wrote in a note to clients.

New Zealand’s dollar, considered a high-yielding currency, fell after the statistics office said retail sales declined for a record sixth quarter, dropping 2.9 percent, adjusted for inflation, from the previous three months. The median estimate of economists surveyed by Bloomberg News was for a 1.5 percent decline.

The currency, which has gained 23 percent against the dollar in the past 12 months, is an “accident waiting to happen,” Greg Gibbs, a foreign-exchange strategist in Sydney at RBS Group Australia Ltd., wrote in a report today.

“We’re forecasting a fall in the New Zealand dollar in the second half of the year, as the global recovery proves protracted and slow,” Gibbs said. “We expect risk appetite to take a step down from its recent recovery.”

Libor Eases

New Zealand is in the sixth quarter of a recession that the central bank has described as the worst in more than three decades. Reserve Bank Governor Alan Bollard has cut the official cash rate by 5.75 percentage points since July to a record 2.5 percent and said last month he is unlikely to increase borrowing costs until late 2010.

Demand for the dollar may weaken after the London interbank offered rate for three-month dollar loans, or Libor, declined to a record low of 0.85 percent yesterday, indicating banks are becoming more willing to lend. The rate may drop another basis point today, according to BNP Paribas SA, for the biggest weekly decline since the week ending Jan. 16.

“Should credit fears ease further, financial institutions, which have built up huge amount of dollar holdings in times of crisis, may start spending in other currencies,” Taisuke Tanaka, managing director and foreign-exchange strategist in Tokyo at Nomura Securities Co., a unit of Japan’s largest securities broker. “If this happens, the dollar may become the weakest currency against almost all currencies.”

South Korea’s won rose for the first time in four days against the dollar as bank borrowing costs declined, spurring demand for emerging-market assets.

“We’re now seeing foreign institutional investors coming back and buying equities in quite a major way,” Peter Redward, Singapore-based head of research for emerging Asia at Barclays Plc, said in a Bloomberg Television interview. “In the short term, people have been buying into the won recovery story. We’re looking for around 1,175 in one year’s time.”

To contact the reporters on this story: Anchalee Worrachate in London at aworrachate@bloomberg.net; Yasuhiko Seki in Tokyo at yseki5@bloomberg.net

Last Updated: May 15, 2009 06:05 EDT