NEW YORK (Bloomberg) — The dollar dropped to a 27-month low against the euro as signs of slowing inflation and growth lessen the currency’s appeal.The US currency also tumbled to the weakest against the British pound in 26 years as investors bet the Federal Reserve will cut borrowing costs later this year while the European Central Bank and Bank of England raise rates. The dollar dropped this week against 14 out of 16 most actively traded currencies tracked by Bloomberg.

“It’s interest rate differentials that are carrying the day against the dollar,” said Paresh Upadhyaya, who helps manage $29 billion in currency assets in Boston at Putnam Investments. “The downward trend in the dollar remains in place” as concern on slowing growth weighs in.

The dollar fell 0.46 percent to $1.3590 per euro this week and 0.82 percent to $2.0026 per pound. The US currency also declined 0.49 percent to 118.68 yen over the period.

The US currency touched $1.3638 per euro on Friday, the lowest since December 31, 2004. The all-time low, $1.3666, was recorded on December 30, 2004.

The dollar tumbled to $2.0133 per pound on April 18, the weakest since June 1981. The dollar also reached a 17-year low of 83.92 US cents April 19 against the Australian currency. It fell to 74.94 US cents April 18 versus the New Zealand dollar, the lowest since June 16, 1982.

“The dollar is fairly fragile right now,” said Nick Bennenbroek, head of currency strategy at Wells Fargo Bank in New York. “The market is getting more conviction that the ECB will continue to raise rates. It is only a matter of time for the euro to test the all-time high.”

Bennenbroek said the euro may test the record next week, and the currency may rise to $1.3750 to $1.38 within three months.

The dollar’s losses this week accelerated after a US government report showed consumer prices excluding energy and food moderated last month. That contrasted with reports from UK and New Zealand indicating accelerating price pressure.

Core consumer prices in the US, excluding energy and food, rose 0.1 percent last month after a 0.2 percent increase in February, the US Labour Department reported in Washington on April 17. Core prices rose 2.5 percent from a year earlier, compared with a 2.7 percent increase in February. Separate US economic reports this week showed declining industrial production and weakness in the labour market.

Slower inflation and growth prompted interest-rate futures traders to raise bets the Fed will reduce its target rate for overnight lending between banks. The odds of a quarter- percentage point cut to 5 percent by its August 7 meeting rose to 25 percent yesterday from 20 percent at the beginning of the week.

The Fed’s benchmark interest rate has been 5.25 percent since June 29. The Frankfurt-based ECB increased its key rate to 3.75 percent last month, the seventh boost since late 2005, and left the door open for a further increase. The BOE’s benchmark rate is 5.25 percent.

The yield advantage of 10-year Treasury notes over similar- maturity German bunds dropped to 0.47 percentage point this week, the lowest since November 2004. A narrowing yield gap dims the allure of dollar-denominated assets.

The economy in the euro zone will grow 2.3 percent this year, beating the 2.2 percent estimate for the US, the International Monetary Fund said in its semi-annual World Economic Outlook released April 11 in Washington.

The euro also reached a record high against the yen this week on speculation the ECB will lift its borrowing costs faster than the Bank of Japan this year. That’s expected to continue encouraging investors to buy European assets funded by loans in Japan, a practice known as carry trade.

ECB council member Axel Weber told Handelsblatt newspaper yesterday that an “extremely positive” economic outlook meant the bank can’t signal it’s finished raising rates. Luxembourg Finance Minister Jean-Claude Juncker said yesterday the euro hasn’t risen “brutally, but appreciated gradually,” and there is “no reason for panic.”

“We strongly believe we’re going to see record highs for the euro,” said Adrian Hughes, currency strategist at Society Generale in London. “The rhetoric from the ECB is relentlessly hawkish on inflation and bullish on growth.”

The euro ended the week virtually unchanged at 161.29 yen, logging a seventh straight weekly gain. It reached 162.43 on April 16, the strongest since January 1999 when the 13-nation currency was introduced.

The pound broke through the $2 level when the UK government on April 17 said inflation accelerated to 3.1 percent last month, more than a percentage point above the Bank of England’s 2 percent target. Interest rate futures traders boosted bets the central bank will lift borrowing costs to the highest among Group of Seven nations.

“The pound has benefited from favourable interest-rate differentials and a better growth outlook in the UK compared with the US,” said Michael Derks, chief markets strategist at Arch Financial Products, a London-based hedge fund. “It’s going to climb to at least $2.05 in the first half.”