Oct. 6 (Bloomberg) -- The euro had its biggest one-day drop against the yen since its 1999 debut as the deepening credit crisis prompted European governments to pledge bailouts for troubled banks while stopping short of coordinated action.

The 15-nation currency fell below $1.35 for the first time since August 2007 after European authorities avoided announcing any plan comparable to the $700 billion U.S. bailout. The yen rose the most against the dollar in a decade as global stocks plunged, damping carry trades. Implied volatility on one-month euro-dollar options rose to a record high.

``People are running for safety,'' said Ram Bhagavatula, a portfolio manager at Combinatorics Capital LLC, a New York-based hedge fund that has $45 million under management. ``There's a huge premium for safety bets: the dollar and the yen. A global recession is coming.''

The euro dropped 5.4 percent to 137.22 yen at 4:04 p.m. in New York, from 145.11 on Oct. 3. It touched 135.05, the weakest since September 2005. The euro fell 1.9 percent to $1.3517 from $1.3772. It earlier reached $1.3456, the lowest since August 2007, when the credit market crisis started to gain momentum. The dollar fell 3.5 percent to 101.62 yen, from 105.32, in its biggest drop since October 1998.

The greenback rose against the euro today on a surge in demand for U.S. currency funding as banks remained reluctant to lend to each other. The dollar gained 5.8 percent last week in its biggest rally since the euro's inception.

`Dollar Liquidity'

``Much of the euro-dollar move has been about the huge demand for dollar liquidity,'' said Alan Ruskin, head of international currency strategy in North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut.

Brazil's real, South Africa's rand and Mexico's peso tumbled on concern a global economic slowdown will cut demand for emerging-market assets. The real dropped as much as 7.8 percent to 2.2037 per dollar, the lowest level since September 2006. The rand fell 5.7 percent to 8.9767, the weakest since January 2003. The peso slid 6.6 percent to 11.9992 against the dollar, the weakest since 1993, when a new peso equivalent to 1,000 old pesos was introduced.

``There's a capitulation of emerging-market currencies,'' said Todd Elmer, currency strategist at Citigroup Global Markets Inc. in New York. ``There were massive flows to emerging markets over the past years. We're seeing a reversal of that, which is providing support to the dollar. There's certainly further room to run.''

German Bailout

The German government and the country's banks and insurers agreed on a 50 billion euro ($68 billion) rescue of Hypo Real Estate Holding AG after an earlier bailout faltered. BNP Paribas SA, France's biggest bank, agreed to take over Belgian units of Fortis after a government rescue of the lender failed.

``Panic is feeding on itself,'' said Daniel Katzive, a senior currency strategist at Credit Suisse Group in New York. ``Concern about the European banking sector is hitting the euro. People don't have a real sense of comfort about the breadth of the problem or the potential policy remedy.''

The yen rose as much as 13.7 percent to 70.32 per Australian dollar, the strongest since March 2003, and 11.6 percent to 45.58 versus the real on speculation a drop below 10,000 in the Dow Jones Industrial Average will discourage trades in which investors get funds in a country with low borrowing costs and buy assets where returns are higher. Japan's 0.5 percent target lending rate compares with 7 percent in Australia and 13.75 percent in Brazil.

Yen's Allure

After seven years of providing the cheapest source of funds for investors buying higher-yielding Australian dollars and Brazil reais, the yen is appreciating as $587 billion of subprime mortgage-related losses force banks to restrict credit. Congress's approval of the U.S. financial bailout on Oct. 3 failed to restore investors' confidence, causing stocks to tumble around the world today.

``This is just pure capitulation and risk aversion across the board,'' said Derek Halpenny, European head of global currency research at Bank of Tokyo-Mitsubishi in London. ``The worst-case scenario last week was for the bill going through but markets failing to respond. We pretty much got the worst-case scenario.''

Investors are pricing in wider price swings in major currencies in the coming month. Implied volatility on one-month euro-dollar options touched a record 19.2 percent, almost double the average of the past year. One-month Aussie-yen volatility surged to 37.4 percent, the highest since the index's inception in 1995. Volatility can erode carry-trade profit.

The prospect of a global economic slump has caused investors to raise bets that the biggest central banks will cut interest rates. The Federal Reserve will cut its 2 percent target lending rate to 1 percent by March 31, and the European Central Bank will reduce its main refinancing rate to 3 percent from 4.25 percent by the end of next year, UBS AG economists led by London-based Larry Hatheway wrote in a report yesterday.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Kim-Mai Cutler in London at kcutler@bloomberg.net

Last Updated: October 6, 2008 16:05 EDT