Barclays Capital sees dollar dropping 2.5% against euro

London: Barclays Capital forecast the dollar will drop 2.5 per cent against the euro in three months as record oil prices increase the US import bill and prevent the European Central Bank from cutting interest rates because of inflation.

The securities unit of Barclays, the UK's third- biggest bank, predicts the dollar will fall to $1.63 per euro, compared with a previous estimate of $1.50, analysts led by David Woo, London-based global head of currency strategy, said. Against the pound, the US currency will weaken to $2.05 versus $1.97.

"The dollar is locked in a vicious circle," they wrote. The currency's drop is causing higher oil prices as oil nations seek to preserve their revenues and "this in turn leads to further dollar weakness as the European Central Bank becomes even less likely to follow Federal Reserve easing."

The dollar has declined about 8.2 per cent versus the euro and Japanese yen in 2008 as oil prices rose to an all-time high of $115.54 a barrel compared with $95.98 on December 31. Against the pound, it has dropped 0.2 per cent. Interest-rate cuts by the Federal Reserve to keep the US economy out of a recession have also reduced demand for dollar-denominated assets.

The dollar dropped 12 per cent against the euro since September as the Fed cut the overnight lending rate between banks by 3 percentage points to 2.25 per cent as subprime-mortgage losses spread.

ECB officials have signalled they are unlikely to cut their benchmark rate from four per cent because lower borrowing costs may further accelerate inflation.

Barclays Capital revised its forecast for the euro to 79 pence in three months, compared with a previous forecast of 76 pence.

Traders are betting the ECB will keep the main refinancing rate at a six-year high. The yield on three- month Euribor contracts expiring in December rose to 4.405 per cent yesterday, the highest this year.

The contracts settle to the three-month inter-bank offered rate for the euro, which has averaged 18 basis points more than the ECB's benchmark rate from 1999 until August.