Sept. 7 (Bloomberg) -- The dollar headed for a weekly decline against the euro and the yen on speculation the U.S. subprime-mortgage crisis will prompt the Federal Reserve to lower interest rates this month.

The currency traded near an one-week low versus the euro after Federal Deposit Insurance Corp. Chairman Sheila Bair said yesterday an additional 1.5 million borrowers with poor credit histories may miss payments. The yield advantage for holding U.S. two-year debt over similar-maturity German bunds narrowed to zero this week for the first time since September 2004.

``The dollar will be slightly weaker today,'' said Robert Rennie, chief currency strategist at Westpac Banking Corp. in Sydney. ``It's hard to see a lot of good news out there.''

The dollar was at $1.3683 per euro at 10:25 a.m. in Tokyo from $1.3691 late in New York yesterday, a decline of 0.4 percent this week. It reached $1.3709 yesterday, the weakest since Aug. 31. The U.S. currency traded at 115.37 yen, compared with 115.38 yen yesterday and 115.77 yen last week. The euro bought 157.88 yen.

Treasury Secretary Henry Paulson yesterday told PBS Television it may take a number of months to work out the strains in capital markets and ``there will be a penalty to our economic growth.'' Interest-rate futures show traders are betting with 100 percent certainty the Fed will cut its benchmark rate at least a quarter-percentage point to 5 percent on Sept. 18.

The U.S. currency headed for a second weekly loss against the yen as a government report today may show the pace of job creation held near the slowest this year. Nonfarm payrolls will be 100,000 in August, from 92,000 in July, according to a Bloomberg News survey of economists, compared with a monthly average of 186,000 the past three years.

Carry Trades

The yen had the biggest gain against the New Zealand dollar among the 16 most-active currencies this week, as investors sold higher-yielding assets funded by loans made in Japan. New Zealand's currency is a favorite of the so-called carry trade because its interest rate is 7.75 percent higher than Japan's.

New Zealand's dollar traded at 79.65 yen from 79.91 yesterday and 81.23 a week earlier. Australia's dollar was at 95.53 yen from 95.66 yesterday and 94.76 last week.

The Bank of Japan's 0.5 percent benchmark rate has caused the yen's weakness so the central bank should raise rates ``as soon as possible,'' Eisuke Sakakibara, Japan's former top currency official, said in an interview.

Stock Markets

``Stock markets are looking a little heavy, and that could give the yen a boost,'' said Osao Iizuka, head of foreign exchange trading at Sumitomo Trust & Banking Co. in Tokyo. ``There's an established pattern for stock declines contributing to a reversal in carry trades.'' The yen may rise to 114.70 a dollar today, he said.

The Nikkei 225 Stock Average fell 0.5 percent. Japan's benchmark stock average has correlation of 0.84 with the dollar- yen since the start of the year. A correlation of 1 would mean equities and currencies moved in lockstep.

Volatility implied by one-week dollar-yen options held at a one-week high of 16.5 percent today. Higher volatility may discourage carry trades, as it implies greater exchange-rate fluctuation risk.

In a carry trade, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the borrowing and lending rate. The risk is that currency market moves erase those profits.

To contact the reporter on this story: David McIntyre in Sydney at dmcintyre2@bloomberg.net; Ron Harui in Singapore at rharui@bloomberg.net

Last Updated: September 6, 2007 21:48 EDT