By John Beresford-Peirse
London, Nov. 7 (Bloomberg) -- The dollar fell to its weakest level in four days against the euro after the Federal Reserve cut its key interest rate to a 40-year low and raised investors' concerns that the biggest economy may be slow to recover.
The Fed yesterday pared its benchmark borrowing rate by 50 basis points to 2 percent, the 10th reduction this year, to foster growth in an economy that's widely expected to fall into recession. The central bank also suggested the economy may take longer to recover after the Sept. 11 attacks than previously thought, leaving open the possibility of another cut next month.
``There are nerves about what the Fed said,'' which is weighing on the dollar, said Simon Rubinsohn, who helps oversee 23 billion pounds ($33.6 billion) at Gerrard Ltd. The currency may also be weaker because some investors who bought it anticipating a reduction have now sold those dollars, he said.
One euro bought 90.38 U.S. cents, up from 89.71 yesterday. The dollar has risen 1 percent against the single currency this quarter. Against the yen, the U.S. currency was little changed at 120.99 from 121.14.
``Concerns about a deterioration in business conditions both here and abroad are damping economic activity,'' the Fed said in a statement accompanying its decision.
Rebound Limited The U.S. economy shrank at a 0.4 percent rate in the third quarter, unemployment rose last month to a five-year high and consumer confidence fell to a 7 1/2-year low. A rebound will be limited by a ``reallocation of resources'' to protect the nation in the aftermath of the terrorist attacks in New York and on the Pentagon, the Fed said.
``The market thought 2 percent would be the base in interest rates,'' said Kamal Sharma, a currency strategist at Commerzbank AG. ``If they cut further next month, it suggests the economy is in an even worse state than previously thought.'' That uncertainty is weighing on the dollar, he said.
The economy's third-quarter contraction was the first since 1993. If analyst expectations of an additional gross domestic product decline in the current quarter prove correct, that would mark the first recession since 1990-91, based on the conventional definition of two straight quarters of contraction.
The Fed's statement led 30 economists surveyed by Bloomberg News to say they expect a quarter-point cut at the Fed's Dec. 11 meeting. Two others expect a half-point reduction and 10 say the Fed will hold rates steady.
``The fact the Fed cut by half a percentage point and still suggested it will cut again means they have a very severe outlook for the economy,'' said Toru Umemoto, a currency strategist at Morgan Stanley Dean Witter & Co.
`Negative' Rates The dollar also may have weakened because of concern the central bank is running out of tools with which to boost growth, analysts said. Considering the consumer price index was 2.6 percent higher last month than a year ago, the Fed's target rate is effectively below zero when adjusted for inflation.
``The euro should benefit from negative real U.S. rates,'' said Kirit Shah, chief market strategist at Sanwa International. That could push the euro up to 92, he said.
Still, the dollar's decline could be limited amid speculation the U.S. may yet recover in the second half of next year and because of questions over the European Central Bank's credibility, analysts said.
While all but one of the 24 economists surveyed by Bloomberg News on Friday predict a cut of at least 25 basis points from 3.75 percent at the ECB's meeting tomorrow, recent statements from ECB council member Ernst Welteke and central bank president Wim Duisenberg have sent mixed signals about the ECB's position on interest rates.
``The ECB's credibility issues keep hampering the euro,'' said Gerrard's Rubinsohn. ``There is a question mark over how they conduct monetary policy.'' A quarter-point cut tomorrow is the ``most likely,'' which probably won't have much effect on the currency.
The ECB also may been seen as reacting to recent weak economic figures from the 12 nations sharing the euro, rather than paring rates earlier in anticipation of a weaker economic outlook, analysts said.
A half percentage point reduction by the ECB would be unexpected by the market and could buoy the euro, said Sharma at Commerzbank.
A report yesterday showed German unemployment had the biggest rise in almost three years in October. A separate report showed consumers and businessmen in the dozen countries sharing the euro grew more pessimistic last month.
A report due at 11 a.m. London time is expected to show German manufacturing orders probably declined for the third time in four months in September.