July 31 (Bloomberg) -- The dollar and fell for a second day against the euro as investors sought higher-yielding currencies as a U.S. government report showed the contraction in the world’s largest economy slowed.

The U.S. currency headed for a fifth month of declines against the pound, its longest run in five years, after a U.K. survey showed consumer confidence held at the highest level since April 2008, adding to signs Britain is emerging from the recession. The yen was poised for a third weekly drop against Australia’s dollar as stocks advanced, spurring investors to buy higher-yielding assets.

“Prices have already priced in a lot of good news, so it’s a lot more important what market participants assume for the next quarters,” said Werner Eppacher, head of foreign exchange at DWS Investment GmbH in Frankfurt, before the report.

The dollar fell to $1.4124 per euro as of 8:35 a.m. in New York, from $1.4075 yesterday, and was at 95.55 yen from 95.56 yen. The Japanese currency weakened to 134.88 per euro, from 134.49.

U.S. gross domestic product contracted at a 1 percent annual rate in the second quarter, following a revised 5.4 percent drop in the first three months of 2009, according to the Commerce Department.

Fed Response

Market participants are beginning “to consider the prospect of the Federal Reserve being able to respond promptly to emerging recovery,” Derek Halpenny, European head of foreign-exchange strategy in London at Bank of Tokyo-Mitsubishi UFJ Ltd. said in a research report today.

The dollar traded at a more than one-week low against the pound after GfK NOP said today that an index of consumer sentiment in the U.K. was unchanged in July at minus 25. The reading is up from minus 39 a year earlier.

The report added to signs that the U.K.’s worst slump in a generation is easing. Nationwide Building Society said yesterday house prices rose for a third month, and a Bank of England report showed mortgage approvals increased. Central bank policy maker Andrew Sentance said last week the bank may pause its asset-purchase plan if forecasts next month point to an improvement.

The U.S. currency traded at $1.6569 per pound, from $1.6493. It strengthened to 85.31 pence per euro, from 85.31 pence.

Corporate Earnings

The yen fell versus 15 of its 16 major counterparts this week as better-than-estimated results from companies including Sony Corp. and Motorola Inc. helped drive global stock gauges to the highest levels this year. The MSCI World Index advanced 0.5 percent today, taking it near the highest level since October.

Japan’s currency traded at 79.22 against Australia’s dollar, from 78.90. Japan’s benchmark interest rate of 0.1 compares with 3 percent in Australia, making the South Pacific nation’s assets attractive to investors.

About three of every four Standard & Poor’s 500 Index companies that released results since June 17 exceeded analysts’ profit estimates, according to data compiled by Bloomberg.

Motorola rose yesterday by the most since November as job cuts helped the biggest U.S. mobile-phone maker report a smaller loss than analysts predicted. Sony, the maker of Vaio computers and PlayStation 3 game consoles, jumped 6.8 percent after cost cuts helped it post a smaller-than-expected loss.

Euro’s Gains

Gains in the euro were tempered as reports showed consumer prices fell by the most in at least 13 years in July even as job losses decreased a month earlier.

Unemployment in the euro region declined to 9.4 percent in June, from 9.5 percent in May, the European Union statistics office said. Economists in a Bloomberg News survey predicted a rate of 9.7 percent.

Prices in the euro area slid 0.6 percent in July from a year earlier, following a decline of 0.1 percent in June, according to a separate report. Economists predicted a 0.4 percent drop.

Investor Skepticism

Gains in the Chicago Board Options Exchange Volatility Index, or VIX, may signal investor skepticism that the global rally in risk appetite will continue, Dresdner-Commerzbank wrote in a report today. The VIX is up 10 percent this week.

“The simple equation share prices equal risk perception is dangerous,” a team led by Ulrich Leuchtmann in Frankfurt wrote in the report. The VIX “normally falls when prices are rising. The fact that that wasn’t the case can be interpreted as a signal that markets are increasingly doubting whether the current stock-market performance will last.”

Investors should buy the U.S. currency against the yen, with a target above 105 per dollar, Goldman Sachs Group Inc. said today in an e-mailed note.

“With structural considerations still pointing clearly to a weaker yen, we think the opportunity for notable yen weakness is the best it has been all year,” Goldman analysts wrote.

To contact the reporters on this story: Matthew Brown in London at mbrown42@bloomberg.net; Yasuhiko Seki in Tokyo at yseki5@bloomberg.net

Last Updated: July 31, 2009 08:37 EDT