Aug. 14 (Bloomberg) -- The euro dropped to a 5 1/2-month low against the dollar after crude oil fell and a report showed Europe's economy contracted for the first time since the 15- nation currency was introduced almost a decade ago.

The dollar has ``bottomed'' against the euro, said Goldman Sachs Group Inc. in a revision of its forecast for the U.S. currency. The pound fell to the lowest in 22 months against the dollar on concern Britain's economy is falling into a recession.

``Not only is the European economy weakening, but the growth outlook is to remain weak,'' said Michael Woolfolk, senior currency strategist in New York at Bank of New York Mellon, the world's largest custodial bank, with more than $23 trillion in assets. ``A further move down in crude oil will be a bullish sign for the dollar.''

The euro fell 0.7 percent to $1.4809 at 4:04 p.m. in New York, from $1.4919 yesterday. It touched $1.4778, the weakest since Feb. 21, compared with the all-time high of $1.6038 set July 15. The euro dropped 0.7 percent to 162.36 yen, from 163.43 yesterday, when it reached a three-month low of 161.40. The dollar increased 0.1 percent to 109.63 yen, from 109.53.

The European currency's decline accelerated after breaking $1.4840, a level at which traders had placed pre-set sell orders, according to Brian Dolan, chief currency strategist at FOREX.com, a unit of online currency trading firm Gain Capital in Bedminster, New Jersey.

The dollar will strengthen to $1.45 per euro in three months, compared with an earlier estimate of $1.56, said Goldman analysts led by London-based Thomas Stolper in a research note today, citing weakening global growth, declining oil prices and an improved U.S. trade balance.

Dollar Outlook

The U.S. currency's advance against the euro has prompted Bank of America Corp. to tell its customers to exit trades betting on more gains. Morgan Stanley still forecasts the greenback will approach a record low by October as the housing slump and credit market losses keep the Federal Reserve from raising interest rates this year.

The euro's 14-day relative strength index against the dollar was at 19 today. A reading below 30 typically signals a change in price direction is imminent.

``What has driven the market in the past several weeks has primarily been events beyond the U.S. -- the slowdown in a number of other developed economies and also the decline in commodity prices,'' said Stephen Malyon, co-head of currency strategy at Scotia Capital Inc. in Toronto. ``I think the U.S. dollar is going to come under some corrective pressure over the coming days, but we need a catalyst for that.''

Weaker Pound

Sterling decreased 0.2 percent to $1.8673 after touching $1.8619, the lowest level in 22 months. The Bank of England cut its economic-growth forecast yesterday, signaling it may reduce its 5 percent target lending rate. Against the euro, the pound rose 0.6 percent to 79.30 pence.

Crude oil for September delivery fell 0.9 percent to $115 a barrel after yesterday's 2.7 percent gain. The euro-dollar exchange rate and oil have had a correlation of 0.9 in the past year, according to Bloomberg calculations. A reading of 1 would mean they move in lockstep.

Europe's gross domestic product shrank 0.2 percent in the second quarter, after growing 0.7 percent in the first three months of the year, the European Union's statistics office said today in Luxembourg. The German economy, Europe's largest, contracted for the first time in almost four years, the Federal Statistics Office said in Wiesbaden.

ECB Outlook

Traders have reduced bets the European Central Bank will increase the main refinancing rate, now 4.25 percent, for a second time this year. The implied yield on the December Euribor futures contract was at 4.95 percent today, compared with 5.04 percent at the end of July.

ECB council member Axel Weber said in a speech in Germany that it's ``premature'' to say slower economic growth will damp inflation in the euro area.

``He's blowing smoke,'' said FOREX.com's Dolan. ``Slow growth is the trading theme in the market. Commodities can't sustain the rebound for 24 hours. It's a bearish indicator for the euro and bullish for the dollar.''

More Americans than forecast filed initial claims for jobless benefits last week, the Labor Department reported, indicating further weakness in the labor market. Sales of existing homes fell to a 10-year low in the second quarter, and the median price of a single-family house dropped 7.6 percent, the Chicago-based National Association of Realtors said.

Futures on the Chicago Board of Trade show a 28 percent chance that the Fed will increase the 2 percent target rate for overnight lending between banks by a quarter-percentage point at the Dec. 16 meeting, compared with 46 percent odds a month ago. Policy makers next meet Sept. 16.

``Given the weak economic backdrop, I can't really see a strong appreciation of the dollar over the next couple of months,'' said Thomas Kressin, a fund manager at Pimco Europe Ltd., in an interview on Bloomberg Television. ``We don't believe that the Federal Reserve will hike interest rates in the foreseeable future.''

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Candice Zachariahs in New York at czachariahs1@bloomberg.net

Last Updated: August 14, 2008 16:05 EDT