May 1 (Bloomberg) -- The dollar rose to the highest level in five weeks against the euro on speculation the Federal Reserve will stop reducing borrowing costs.

The currency increased versus the Norwegian krone, Swiss franc and pound a day after the Fed cut its target lending rate by a quarter-percentage point to 2 percent and said easing has been ``substantial.'' The pound appreciated to the highest level in more than a month against the euro as the Bank of England said the worst of the credit crisis in the U.K. may be over.

``The market is saying the economy is bottoming,'' said Samarjit Shankar, director of strategy for the global markets group in Boston at Bank of New York Mellon, the world's largest custodial bank, with more than $20 trillion in assets under administration. ``We may possibly see a turn in monetary policy.''

The dollar rose 1 percent to $1.5466 against the euro at 4:14 p.m. in New York, from $1.5622 yesterday. It touched $1.5430, the strongest level since March 25. The dollar increased 0.5 percent to 104.38 yen, from 103.91. The euro fell 0.5 percent to 161.41 yen, from 162.29. The dollar rose 0.6 percent to $1.9751 per pound, from $1.9866 yesterday.

Since dropping to the all-time low of $1.6018 per euro on April 22, the dollar has increased 3.5 percent on speculation the Fed will hold borrowing costs steady and economic growth in Europe will start to slow.

Futures on the Chicago Board of Trade show an 82 percent chance policy makers will keep the fed funds target unchanged when they next meet June 25. The balance of bets is for a cut of a quarter-percentage point. The European Central Bank has kept its benchmark rate at a six-year high of 4 percent since June to curb inflation.

The U.S. Dollar Index, which measures the currency against six major counterparts, touched 73.328, the highest level since March 11. The index fell to 70.698 on March 17, the lowest since its 1973 inception.

Sterling climbed 0.4 percent to 78.31 pence per euro after reaching 78.02 pence, the highest since March 26. The Bank of England said in its twice-yearly financial stability report that ``risk appetite will return gradually'' in the coming months.

``The pound's strength after the BOE report is manifesting itself in the sell-off of the euro against the pound,'' said Adam Cole, head of currency strategy at Royal Bank of Canada in London. ``This is dragging the euro down against the dollar.''

Gulf State Pegs

Gulf states are thinking about abandoning currency pegs to the dollar after its 13 percent drop against the euro in the past year stoked inflation, Kuwaiti Finance Minister Mustafa al- Shimali said in an interview late yesterday.

``Yes, there are some'' Gulf Cooperation Council states considering dropping their pegs to the dollar, al-Shimali said. ``Some countries will do what we are doing.''

Kuwait's dinar has appreciated 7.9 percent against the dollar since the nation eliminated its peg to the U.S. currency in May 2007.

The Canadian dollar fell the most in more than six weeks against the U.S. dollar on speculation a weakening economy will force the Bank of Canada to make further cuts in the target lending rate, now 3 percent. The currency dropped 1.1 percent to C$1.0191 per U.S. dollar, the biggest decline since March 19.

The dollar extended its gain versus the euro after a report from the Institute for Supply Management showed U.S. manufacturing contracted less than forecast in April. Its index was at 48.6, while the median forecast of 78 economists surveyed by Bloomberg News was for a reading of 48. Fifty is the dividing line between contraction and expansion.

The U.S. currency rose 1.3 percent against the Norwegian krone and 1.5 percent versus the Swiss franc today.

Bond Spread

The yield advantage of two-year German bunds over comparable-maturity U.S. Treasuries has narrowed to 1.52 percentage points from 1.85 percentage points at the end of March, making dollar-denominated assets more attractive.

The U.S. currency has lost 10 percent against the euro since the Fed started to lower its target rate for overnight lending from 5.25 percent in September.

The drop is likely to slow because the U.S. currency is ``completely bombed out,'' said Mark Mobius, who oversees $47 billion in emerging-market equities in Hong Kong at Templeton Asset Management Ltd., in an interview on Bloomberg Television. The Fed may cut its target lending rate to 1 percent as U.S. housing foreclosures mount, he said.

The euro declined 1 percent against the South Korean won and the Brazilian real today on speculation the European economy is losing momentum. The ECB will reduce its target lending rate to 3.75 percent by the end of September and 3.50 percent by year-end, according to economists surveyed by Bloomberg News.

``We are seeing selling pressure on the euro across the board,'' said John McCarthy, director of currency trading at ING Financial Markets LLC in New York. ``The focus is shifting to Europe, with the belief that the worst is over here now while Europe is slowing down.''

To contact the reporter on this story: Ye Xie in New York at yxie6@bloomberg.net

Last Updated: May 1, 2008 16:18 EDT