Jan. 7 (Bloomberg) -- The dollar fell from a more-than- three-week high against the euro after a private report showed the U.S. job market deteriorated last month, reinforcing investor expectations for a protracted recession.

The dollar also depreciated versus the yen and the British pound as Fed policy makers said yesterday in the minutes of the Dec. 15-16 meeting that they saw “substantial” risks to the slumping economy and pledged to expand emergency loans if necessary. U.K.’s pound strengthened to less than 90 pence per euro for the first time since Dec. 17.

“For the first time in a while, economic data is becoming important,” said Richard A. Gluck, principal at Trilogy Global Advisors LLC in New York, which has about $10 billion in assets under management. “Until we see either real signs of economic resurgence in the U.S. or further deterioration in other regions, it’s hard to see the dollar appreciate versus the euro.”

The dollar weakened 0.9 percent to $1.3657 per euro at 1:27 p.m. in New York from 1.3536 yesterday, when it touched $1.3313, the strongest level since Dec. 12. The U.S. currency fell 1 percent to 92.79 yen, from 93.65. The euro traded at 126.82 yen from 126.75.

Brazil’s real and South Africa’s rand led a decline in currencies of commodity exporters as raw materials from oil to gold tumbled. The real fell 3.1 percent to 2.247 per dollar while the rand lost 1.6 percent to 9.518. Crude oil for February delivery fell 9 percent to $44.12 per barrel.

Dollar Index

Companies in the U.S. eliminated 693,000 jobs in December, the most since records began in 2001, ADP Employer Services said today. The median forecast of a Bloomberg News survey of 24 economists was for a reduction of 495,000.

The Dollar Index on ICE futures, which tracks the greenback versus six major U.S. trading partners, fell 0.8 percent today even as U.S. stocks declined the most in two weeks.

The dollar’s tendency to rise as investors seek protection from stock-market declines is ending as economic growth becomes the main driver of the U.S. currency, foreign-exchange strategists at BNP Paribas said.

The dollar has rallied 30 percent versus the Brazil’s real and gained 4 percent against the euro last year as investors sought safety in U.S. Treasuries after the MSCI World stock index slumped 42 percent and writedowns and losses at the world’s largest financial institutions since the start of 2007 total $1 trillion.

‘Dead Cat Bounce’

The rally stalled since mid-December as investors sold Treasuries for higher-yielding assets elsewhere. The greenback has lost 7 percent against the New Zealand dollar, the Australian dollar and the South African rand since Dec. 15.

The U.S. currency will “re-assert itself” as deterioration of global economy will lead U.S. investors to sell overseas assets and send money back home, currency strategists at Merrill Lynch & Co. Inc. wrote in a research note to clients today.

“It seems to be somewhat courageous to adopt a pro high yield or commodity linked currency stance on what is most likely to be a dead cat bounce in some data amid a severe rise in global unemployment,” the strategists wrote. “We expect repatriation and re-balancing demand for the U.S. dollar to re- build over the first quarter, while recent euro strength looks over-extended.”

Merrill recommended investors sell the euro versus the dollar through options, sell the pound versus the dollar and sell the euro versus the Swiss franc. The dollar will rise to $1.15 per euro by the end of March and appreciate to 58 cents versus the Aussie from 71 cents today, according to Merrill Lynch’s forecasts.

Interest Rate Expectations

The dollar rose to the three-week high versus the euro yesterday on speculation the European Central Bank will lower its interest rates from 2.5 percent next week as the region entered a recession.

Economists in a Bloomberg survey forecast the European Central Bank will cut interest rates to 1.50 percent by June, and refrain from reducing borrowing costs beyond that. The Fed lowered its target rate between zero and 0.25 percent last month and pledged to keep the rate low.

“The euro sell-off against the dollar in recent days seems to be running its course,” said David Powell, a currency strategist in London at Bank of American Corp. “The ECB’s less aggressive easing will continue to support the euro in the near term. We expect the central bank to cut by 50 basis points next week. But if you put that in contrast to the Fed, the ECB is much more restrained.”

Powell, who predicts the euro will rise above $1.40 by the end of this quarter, said the Fed is likely to keep its fed funds rate near zero into early 2010.

Slowing Inflation

Some Fed officials saw “the distinct possibility of a prolonged contraction” stemming partly from stresses in financial markets, according to the minutes released yesterday.

The euro fell as low as 89.61 British pence from 90.70. It fell by 5.3 percent in the last two days, the biggest drop since the currency’s debut in 1999, on speculation slowing inflation will give the ECB room to cut interest rates to tackle a recession.

The British currency slid 23 percent against the euro last year, its biggest annual drop since the common currency’s debut, as U.K. policy makers cut rates by more than the ECB as the British economy entered its first recession in 17 years.

The Bank of England will lower its benchmark rate by half a percentage point to an all-time low 1.5 percent when it announces a policy decision tomorrow, according to a Bloomberg survey.

“The British pound has appreciated because some people think the economy will recover more quickly than Europe which is reluctant to go down to the same road as the U.K.,” said Trilogy’s Gluck. “It’s based on hope rather than faith.”

Currency Funds

Foreign-exchange funds gained 0.08 percent in November, as volatility in the currency market increased, according to Parker Global Strategies LLC.

The Parker FX Index, which tracks by 63 firms managing more than $33 billion in assets, advanced 4.38 percent last year through November, the Stamford, Connecticut-based firm said in a statement.

Volatility on major currencies doubled to 20 percent by the end of November, from 9.4 percent on July 31, according to an index compiled by JPMorgan Chase & Co. It is at 19.69 percent today.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Anchalee Worrachate in London at aworrachate@bloomberg.net

Last Updated: January 7, 2009 13:35 EST