Jan. 2 (Bloomberg) -- The dollar fell against the euro, extending last year's 10 percent decline, on concern the slowdown in U.S. manufacturing will give the Federal Reserve more reason to lower interest rates.

The dollar dropped near the lowest in three weeks versus the yen on speculation the Institute for Supply Management will say today factories expanded production at the slowest pace in 11 months in December. The U.S. currency weakened against 13 of the 16 most-actively traded currencies as traders bet the central bank will reduce borrowing costs at least twice in 2008.

``The dollar's on the defensive,'' said Robert Minikin, a currency strategist in London at Standard Chartered Plc. ``We expect two interest-rate reductions'' of a quarter-point each by the end of March.

The U.S. currency declined to $1.4688 per euro at 6:51 a.m. in New York, from $1.4592 yesterday. It dropped to $1.4967 on Nov. 23, the lowest since the euro's introduction in 1999. The dollar slipped to as low as 111.33 yen and was little changed at 111.56 yen, from 111.64 yen. The euro rose 0.7 percent to 163.88 yen, extending its eighth consecutive annual gain versus the Japanese currency.

The dollar weakened the most against the New Zealand dollar, falling 0.9 percent to 77.37 U.S. cents. It declined 0.6 percent versus Canada's dollar to 98.86 cents from 99.26. It also fell 0.7 percent to 1.1252 Swiss francs.

Australia's dollar advanced for a second day against the U.S. currency after a private report showed manufacturing expanded at the fastest pace in more than five years in December, buoyed by consumer and business spending. The currency rose 0.6 percent to 88.11 U.S. cents.

Emerging Markets

The dollar also dropped 0.4 percent versus the South African rand and 0.3 percent against the Turkish lira.

Brazil's real, Turkey's lira and South Africa's rand may weaken at least 3.75 percent after gains of more than 14 percent in 2007, according to the median forecasts of banks and securities firms surveyed by Bloomberg News. The lira and rand last fell in 2006, while the real has strengthened for five straight years.

The dollar fell against the euro in 2007 as the Fed lowered its benchmark rate by 1 percentage point to 4.25 percent since September. The euro gained 10.6 percent last year as the European Central Bank raised its main refinancing rate twice to 4 percent, the highest in six years.

Rate Bets

The chance the Fed will cut its target rate for overnight lending between banks by a quarter-point to 4 percent at its Jan. 30 meeting rose to 92 percent from 76 percent a week ago, according to futures contracts on the Chicago Board of Trade. The odds of a reduction to 3.75 percent at its March 18 meeting are 61 percent.

The U.S. Dollar Index traded on ICE Futures in New York dropped to 76.26 today, near a three-week low, and was recently at 76.29. The index, which values the currency's performance against those of six of its biggest trading partners, fell 8 percent for a second year in 2007.

The ISM's factory index fell to 50.5 in December from 50.8 the previous month, the Tempe, Arizona-based group may report, according to the median estimate of economists surveyed by Bloomberg News. A reading of 50 is the dividing line between expansion and contraction.

The dollar may fall to $1.4750 this week, according to Tony Morriss, a currency strategist at Australia & New Zealand Banking Group Ltd. in Sydney.

The yen fell as the Australian manufacturing report spurred traders to buy higher-yielding assets with money borrowed in Japan in so-called carry trades.

Kuwait Fund

The Japanese currency declined against Norway's krone and Sweden's krona on speculation investors resumed carry trades after the Financial Times said yesterday the Kuwait Investment Authority, a $213 billion sovereign wealth fund, wants to invest in the U.S. financial services.

``The Australian economy is doing quite well and the FT report is a positive for risk-taking sentiment,'' said Lee Wai Tuck, a currency strategist at Forecast Singapore Ltd. ``These could be factors for putting back on carry trades. There's some yen selling.''

Japan's currency declined 0.2 percent to 20.56 per Norwegian krone and 0.6 percent to 17.37 per Sweden's krona.

Merrill Lynch & Co., Morgan Stanley, Citigroup Inc. and Bear Stearns Cos. sold $20 billion in stakes last year to sovereign wealth funds such as the Abu Dhabi Investment Authority to bolster capital eroded by credit-market losses.

Japan's benchmark interest rate of 0.5 percent, the lowest among major economies, compares with 5.25 percent in Norway, 4 percent in Sweden and 6.75 percent in Australia.

Carry Trades

In carry trades, investors borrow funds in countries with low lending rates and use the cash to buy assets in nations that offer higher returns. The risk is currency fluctuations may erase the profits earned between the two interest rates.

The euro may extend last year's 3.7 percent advance against the yen before a German report tomorrow that economists said will show unemployment fell to the lowest in more than 14 years in December, suggesting Europe's economy is resilient enough to withstand higher borrowing costs.

``We don't expect the ECB will have to cut interest rates this year, as inflation is expected to remain too high over the next months to allow such a move,'' said Christoph Rieger, fixed- income strategist at Dresdner Kleinwort in Frankfurt. ``Later in the year, the economy will have strengthened.''

Germany's jobless rate dropped to 8.5 percent in December, the lowest since April 1993, according to a Bloomberg survey of 23 economists.

Traders increased bets the ECB will raise borrowing costs this year, interest-rate futures show. The implied yield on the March Euribor contract rose to 4.54 percent today from 4.53 on Dec. 31.

To contact the reporters on this story: Lukanyo Mnyanda in London at lmnyanda@bloomberg.net; Ron Harui in Singapore at rharui@bloomberg.net

Last Updated: January 2, 2008 07:01 EST