Nov. 2 (Bloomberg) -- The Australian dollar declined on speculation a drop in the price of oil to a four-week low may lead to higher U.S. interest rates, cutting demand for Australian assets such as government bonds.

The yield gap between Australian and U.S. two-year government bonds narrowed to 2.48 percentage points from 2.53 percentage points on Oct. 29, on speculation the drop in oil means energy costs will stifle U.S. economic growth less than some had expected. A narrower yield premium may lure investors away from Australian assets.

``I'm inclined to believe the Australian dollar will test lower by Friday,'' said Richard Franulovich, a New York-based currency strategist at Westpac Banking Corp. ``With crude oil slipping away, that will benefit the U.S. dollar.''

The Australian dollar bought 74.49 U.S. cents at 3:28 p.m. in Sydney from 74.57 cents in Asia yesterday. The currency will decline to 74 cents by the end of the week, said Franulovich.

Crude oil for December delivery fell 0.2 percent to $50.01 a barrel in after-hours electronic trading on the New York Mercantile Exchange. Yesterday, December crude fell 3.2 percent to $50.13, the lowest closing price since Oct. 4. Oil reached $55.67 on Oct. 25, the highest since futures began trading in 1983.

The Australian dollar gained 3.3 percent since the price of crude moved above $50 a barrel on Oct. 5.

``Stabilizing'

Strategists such as Alex Schuman, manager of foreign- exchange strategy at Commonwealth Bank of Australia, said demand for the Australian dollar may rise if oil prices stay at their current level.

``The Australian dollar is rising strongly on good news and stabilizing on bad news, so this is a good sign the market isn't as long as some people think,'' said Schuman, who is based in Sydney. The currency may gain to 77 cents in the next month, he said.

Futures traders increased bets the Australian dollar will gain against its U.S. counterpart, figures from the Washington- based Commodity Futures Trading Commission showed on Oct. 29.

Net longs, the difference between the number of wagers by hedge funds and other large speculators on an advance in the Australian dollar compared with those betting on a drop, were 28,530 on Oct. 26, the second highest ever, compared with 22,509 a week earlier.

Typically, investors holding so-called longs would sell the currency to limit losses on expectations of a decline.

Yield Gap

The Reserve Bank of Australia meets today for its policy- setting meeting with all 23 economists surveyed by Bloomberg News forecasting the bank will leave its overnight cash rate target at 5.25 percent as it has done since December.

The bank announces its decision at 9:30 a.m. tomorrow in Sydney.

The 6.25 percent Australian government bond maturing in April 2015 fell 0.308, or A$3.08 per A$1,000 face amount, to 106.836, pushing the yield four basis points, or 0.04 percentage point, higher to 5.39 percent. Like-maturity U.S. Treasuries yield 4.08 percent, up 6 basis points since yesterday.

President George W. Bush and Senator John Kerry were deadlocked in seven national polls of likely voters released in the final hours before today's election.

``A big concern for the Australian dollar is a rise in U.S. Treasury yields, which could be particularly detrimental for high- yielding currencies,'' said Ashley Davies, a currency strategist at UBS AG in Singapore. ``A decisive outcome for the presidential election will benefit U.S. yields'' and weaken the Australian dollar to 73.50 cents, he said.

To contact the reporter on this story: Chris Young in Sydney at cyoung12@bloomberg.net

Last Updated: November 1, 2004 23:29 EST