By Bo Nielsen and Ron Harui

Sept. 25 (Bloomberg) — The dollar snapped two days of gains against the euro after President George W. Bush said the U.S. may face a “painful” recession and as traders bet on a Federal Reserve interest-rate cut next month.

The dollar also weakened versus the Swiss franc before a U.S. government report today that may show home sales dropped in August, extending the worst housing slump in 17 years. The British pound rose against the U.S. currency after policy maker Andrew Sentance said the Bank of England must temper its response to the credit crisis and stick to its inflation focus.

“The prospects of loose fiscal and monetary conditions in a economy that’s slowing rapidly is hitting the dollar, said Simon Derrick, chief currency strategist in London at Bank of New York Mellon Corp. Treasury Secretary Henry Paulson’s $700 billion bank-bailout package “may restore confidence in a lot of things but it won’t restore confidence in the dollar.”

The dollar fell to $1.4686 per euro as of 6:35 a.m. in New York, from $1.4621 yesterday. The currency declined to 105.91 yen from 106.11. The euro was at 155.57 yen from 155.15. The U.S. currency dropped to $1.8553 against the pound from $1.8465, and to 1.0836 versus the franc from 1.0916.

Futures contracts on the Chicago Board of Trade showed 80 percent odds the Fed will cut borrowing costs in October as Congress mulls Paulson’s rescue plan. That compares with 58 percent odds on Sept. 23.

`Grave Threats’

Bush said in an address to the nation that without the rescue the U.S. will suffer “a long and painful” recession. Paulson said the financial system is “frozen to a large extent.” Fed Chairman Ben S. Bernanke said the U.S. faces “grave threats” to market stability.

The euro may rise as high as $1.53 versus the U.S. currency as the market refocuses on economic fundamentals once the bailout package is in place, Citigroup Global Markets Inc. said in a note sent to Bloomberg yesterday.

“There’s no alternative to the Paulson plan and at the end of the day they will sign on the dotted line,” Hans-Guenter Redeker, the London-based global head of currency strategy at BNP Paribas SA, France’s biggest bank, said on Bloomberg Television today. That will weaken the dollar “a little bit.”

The collapse of Lehman Brothers Holdings Inc. and the U.S. government takeover of American International Group Inc. has caused a seizure in lending between banks. The three-month London interbank offered rate, or Libor, the rate at which banks charge each other for loans in dollars, rose to 3.77 percent today, the highest relative to the Fed’s target rate on record.

U.S. Home Sales

Sales of new houses in the U.S. fell to an annual rate of 510,000 last month, from 515,000 in July, according to the median forecast of economists surveyed by Bloomberg News. Sales declined to a 503,000 pace in June, the lowest since 1991. The Commerce Department report is due at 10 a.m. in Washington.

The dollar has fallen 4.6 percent against the euro since touching a one-year high of $1.3882 on Sept. 11. The dollar reached $1.6038 on July 15, the weakest level since the European currency made its debut in 1999.

The British pound climbed against 15 of the 16 most-traded currencies after Sentance said policy makers should guard against “allowing the economic slowdown to develop into a deflationary spiral which would not be consistent with our mandate to meet the 2 percent inflation target.”

Risk Reduction

The yen may rise as slowing export growth added to evidence of a global economic slump, prompting investors to reduce purchases of higher-yielding assets financed in Japan, so-called carry trades. In such transactions, investors get funds in a country with low borrowing costs and invest in one with higher interest rates, earning the spread between the two. The risk is that currency market moves erase those profits. The benchmark interest rate is 0.5 percent in Japan, compared with 13.75 percent in Brazil and 5.25 percent in South Korea.

Bank of Japan board member Tadao Noda said today that global growth will slow, threatening the bank’s expectation that Japan’s economy will recover after shrinking in the second quarter. Economic and Fiscal Policy Minister Kaoru Yosano said a drop in Japan’s exports was triggered directly and indirectly by the U.S. subprime crisis.

“Investors may become risk-averse,” said Yuji Saito, head of the foreign-exchange group in Tokyo at Societe General SA, France’s largest bank by market value. “The yen may be bought.”

Japan’s exports grew 0.3 percent in August from a year earlier after rising 8 percent the previous month, the Finance Ministry said today in Tokyo. The yen climbed 0.7 percent to 10.95941 versus the Korean won, and advanced 0.4 percent to 56.8295 against Brazil’s real.

Taiwan’s dollar lost 0.2 percent to 32.008 per U.S. dollar after the central bank unexpectedly reduced interest rates for the first time since 2003, saying the deepening global financial crisis has heightened the risk of an economic slump.

Governor Perng Fai-nan and his board cut the discount rate on 10-day loans to banks by 12.5 basis points to 3.5 percent. Only two of 13 economists surveyed by Bloomberg News expected the decision.

This article was derived from bloomberg.com/apps/news?pid=20601103&sid=aLqCUDdQqfZs&refer=us