THE EURO, once the butt of currency dealers’ jokes, is now enjoying its place in the sun. Last week the currency traded above $1.50 against the beleaguered dollar for the first time in its nine-year history.

The dollar’s fall also helped to produce a grim new milestone for energy users. Its weakness contributed to a rise in oil prices to almost $103 a barrel. Though calculations vary, on most measures that is the highest oil price in inflation-adjusted terms in the modern era, exceeding the level reached in 1980 in the aftermath of the fall of the shah of Iran in 1979.

As with other dollar-priced commodities, the American currency’s fall has a twin impact on oil. It leads to a compensatory rise in prices and encourages investors to seek what they see as the safer haven of commodities. Both effects conspire to push prices higher.

The dollar has been weaker than this in its history. Against the “synthetic” euro — the single currency’s component currencies before its inception — it was close to today’s levels in the early 1990s and weaker in the 1980s.

But last week nevertheless represented a watershed, and an extraordinary transformation in the fortunes of the euro. Compared with its first two to three years, when the euro traded at barely more than 80 US cents, the turnround has been remarkable. From that low point, the euro has almost doubled in value.

Against a basket of currencies, meanwhile, the dollar has fallen by more than 25% over the past six years. But why is it happening, will it last, and what does it mean for the pound?

The dollar is falling because of deepening gloom about the American economy. Last week brought news of an accelerating decline in the price of new homes, as the housing recession there deepens, with about 10 months of unsold properties for both new and existing homes representing a big drag on the market.

Compounding the gloomy figures was a downbeat assessment from Ben Bernanke, chairman of the Federal Reserve Board. In testimony to Congress on Thursday he warned of an economic situation that had become “distinctly less favourable” since the summer and of financial markets that remained under “considerable stress”.

Bernanke, while dismissing comparisons with the stagflation of the 1970s, also warned that inflation posed a problem for the Fed and that its task in heading off recession was more complicated than before 2001, when America’s economy experienced its last serious downturn.

A reassurance from President George Bush that America’s economy would not slide into recession counted for less among currency dealers than Bernanke’s downbeat assessment. With the president firmly in the lame-duck phase of his second term, they are more interested in what the Fed does and what policies Bush’s successor will introduce.

Some analysts see the dollar’s fall as far from over. Greg Anderson, currency strategist with ABN Amro in New York, predicts that the dollar will suffer an overall decline of 7%-10% during this year and that the euro will end the year at $1.56. A more pronounced decline was unlikely, he said, because of the need for America to attract foreign capital to replace lost wealth.

Other economists believe, however, that the dollar’s fall may be overdone. Paul Mortimer-Lee, global head of market economics at BNP Paribas, published a report on Friday called Doom and Gloom. His theme was not that people had underestimated the downside risks for America but that they were downplaying its spread to other parts of the world, in particular Europe.

“We think we are in the blowout stage for the dollar,” he said. “When you look at US markets, there’s a lot of bad news already priced in. I don’t think the markets have realised how much trouble the eurozone is in. While investment is holding up, consumer confidence is very weak. We expect a contraction in GDP gross domestic product] in the eurozone in the second quarter and that ultimately the ECB [European Central Bank] will be forced to cut.”

That will mean, according to BNP Paribas, that the ECB will cut its key interest rate from the current 4% to 3.75% in June and to 3.25% by the end of the year. The euro, on this basis, will drop back to $1.40 by the middle of the year.

Others are also sceptical about the euro’s strength against the dollar persisting. Paul Robinson, a currency strategist with Barclays Capital, said the dollar had suffered as a result of a series of factors, including the stability of world equity markets, but that these factors were likely to diminish. “We don’t think the dollar’s weakness is going to persist,” he said.

Figures on Friday suggested that the gloss was coming off the European economy. The European Commission’s economic sentiment indicator dropped to a two-year low, while inflation, at 3.2% in January, was above the ECB’s 2% target. Eurozone unemployment, at 7.1% of the workforce, is set to rise. But whether Europe generates enough gloomy headlines to change investors’ perceptions that America is the weakest link in the global economy remains to be seen.

With the euro and the dollar creating all the excitement, and the American currency falling on Friday to a three-year low against the Japanese yen, the pound has been watching from the sidelines.

Sterling has been tugged both ways by the dollar’s fall against the euro. On the one hand, the pound has been pushed back towards the $2 level by the greenback’s drop. But sterling has also dropped against the euro to a record low of just above ¤1.30.

If economists are right, and the dollar’s weakness is overdone, these trends should reverse themselves. The pound will climb a little against the euro but fall somewhat against the dollar. The Bank of England will be hoping that as some of the current pressures unwind, the pound does not take its cue from the dollar and fall against everything.

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