The dollar fell sharply yesterday as currency markets digested the latest evidence of weakening in the US economy.

In its latest analysis the US Federal Reserve Bank has warned that the world's largest economy is slowing down. Its so-called Beige Book also suggested that price pressures were moderating in spite of higher oil prices.

Expectations of an increase in the Fed's main interest rates reversed in reaction to the news. Markets had attached a 60 per cent likelihood of US rates rising from 5.25 per cent to 5.5 per cent after the Fed's next policy meeting on August 8th. The dollar fell to $1.27 against the euro in reaction to the news.

"Markets are responding to the Beige Book yesterday which suggested the US economy would slow gradually and inflation was unlikely to accelerate. This is leading investors to believe the Fed may not raise rates on August 8th," Richard Duncan head of investment strategy at ABN AMRO Asset Management said yesterday.

Combined with a stronger euro, this development may ease pressure on the European Central Bank (ECB) to raise interest rates over the medium term, although analysts predict that an ECB rate rise is virtually certain to occur next Thursday.

But fears of US rate tightening could be revived soon, analysts predicted yesterday. According to new data published yesterday US orders for durable goods rose by more than expected in June, while July jobless claims were lower than expected.

"We are at a critical juncture in terms of expectations, and we think continued higher inflation expectations will force the Fed to move twice more," Robert Sinche, head of global foreign exchange at Bank of America said yesterday.