THE EURO was badly burnt yesterday after the Republic rejected the Lisbon Treaty, leaving the EU in political disarray.

The euro dropped sharply on the news, as it did three years ago when the French and Dutch rejected the original constitution. It ended the week 2.6 per cent down against the dollar at $1.5379, its biggest fall since 2005, and 1.5 per cent lower against sterling at £0.7887.

"Even if a rejection won't completely scuttle the project, it is more than embarrassing," said analysts at Brown Brothers Harriman. "Surely it is premature to conclude that the euro is on the verge of replacing the dollar in the world economy."

Geoffrey Yu, a currency analyst at UBS AG, said the rejection of the treaty undermines the EU's public legitimacy and may influence public sentiment in countries contemplating joining the euro zone.

In a note to clients, he said: "This change may undermine the ECB's price stability mandate in favour of a growth mandate."

The dollar made its biggest weekly gain in more than three years last week after a string of hawkish comments from US policy-makers threw momentum behind it, convincing traders the US rate-cutting cycle was over.

Ben Bernanke, chairman of the Federal Reserve, said the danger of a "substantial downturn" in the US economy had receded over the past month, but that inflation risks were increasing.

A flurry of similar comments from other Fed and treasury officials followed, with several making explicit references to the need for dollar strength to damp inflation.

Such comments can pump up but rarely sustain a currency rally, but this week, two key pieces of data added weight to the idea the Fed might start raising rates.

US retail sales last month rose twice as much as forecast in a sign that the government's tax rebates were stimulating the economy, and data yesterday showed US inflation jumped last month to 4.2 per cent.

Apart from a wobble on Wednesday, the dollar's rally gathered pace through the week as the market began to suspect the US would use the G8 meeting at the weekend to secure international support for the currency.

Currencies are not officially on the agenda for the meeting of finance ministers, which is set to focus on the inflationary threat of the commodity boom. But some officials talked up the close correlation between the dollar's slide over the past 12 months and the doubling oil price in the same period.

"One of the few things policymakers can do about commodity prices is present a united front backing a stronger dollar, and hope that will send commodity prices falling," said Adam Cole of RBC Capital Markets. "Being short the dollar now is a risky strategy."

French finance minister Christine Lagarde, before meeting her G8 counterparts yesterday in Osaka, Japan, said that the dollar's increase versus the euro was "very satisfying". The group comprises the US, Japan, Germany, the UK, France, Italy, Canada and Russia. - (Financial Times service/ Bloomberg)