Aug. 21 (Bloomberg) -- The dollar fell against the yen before a central bank report forecast by economists to signal manufacturing contracted, undermining the case for the Federal Reserve to raise interest rates.

The U.S. currency also weakened against the euro on speculation futures traders will pare bets that the dollar will gain. The British pound traded close to a two-year low versus the dollar as minutes of the Bank of England's August meeting indicated expectations for the British economy worsened.

``The dollar has been recently heavily overbought despite deteriorating U.S. economic fundamentals,'' said Keiichi Iguchi, a currency dealer in Tokyo at Resona Bank Ltd., a unit of Japan's fourth-largest lender by market value. ``Weaker economic data could spark sharp dollar-selling'' as traders unwind their positions, he said.

The dollar fell to 109.65 yen as of 9:47 a.m. in Tokyo from 109.86 in New York yesterday. It also declined $1.4779 per euro from $1.4747 yesterday, when it climbed 0.2 percent. The euro was at 162.08 yen from 162.03. It reached 160.87 on Aug. 19, the lowest level in three months.

The dollar may fall to $1.50 per euro in a few days should it fall below $1.48, Iguchi forecast.

The U.S. currency has gained 7.8 percent versus the euro since touching the all-time low of $1.6038 on July 15 and appreciated 1.6 percent this month against the yen as economies in Europe and Japan shrank and crude oil fell more than 20 percent from its record of $147.27 a barrel last month.

`Kind of Scary'

Futures traders are betting for the first time since March 2007 that the dollar will rise against the euro, yen and British pound. The difference wagers by hedge funds and other large speculators on a gain in the dollar compared with those on a drop, known as net longs, was 24,060 on Aug. 12, compared with net shorts of 20,886 a week earlier, data from the Washington- based Commodity Futures Trading Commission showed Aug. 15.

The 14-day relative strength index of the euro against the dollar was at 23.4. A level below 30 signals Europe's single currency's losses may be excessive and a reversal may occur.

``It's kind of scary to conduct euro-selling further from this stage, as it has been already sold a lot against the dollar,'' said Motonari Ogawa, director of currency trading in Tokyo at Barclays Capital Inc., a unit of the U.K.'s third- biggest bank. ``One small thing could lead to a correction.''

Crude oil today increased 0.2 percent to $115.86 a barrel. The euro-dollar exchange rate and oil have had a correlation of 0.9 in the past year, according to Bloomberg calculations based on their value changes. A reading of 1 would mean they move in lockstep.

Manufacturing Slump

The Fed Bank of Philadelphia's general economic index will be minus 12.6 in August from minus 16.3 in the prior month, according to the median forecast of 62 economists surveyed by Bloomberg News. Readings less than zero signal a decline. The bank releases the report at 10 a.m. in New York.

The pound traded at $1.8632 from $1.8621 yesterday. It reached $1.8512 on Aug. 15, the lowest level since July 2006. BOE policy makers split three ways when they kept the target lending rate unchanged at 5 percent earlier this month, minutes of the Aug. 7 meeting showed yesterday. Seven policy makers voted for the move, while one official called for an increase and another for a cut.

Gains in the euro may be limited as Germany's Economy Ministry yesterday said the economic outlook has worsened even beyond the second quarter, when gross domestic product shrank for the first time in four years.

The dollar has traded in a range of $1.46 to $1.48 per euro this week after advancing for five consecutive weeks, the longest stretch of gains since February 2006.

Fannie Mae, Freddie Mac

The U.S. currency also weakened on speculation credit- market losses in the U.S. will deepen. Fannie Mae and Freddie Mac shares tumbled in New York trading to the lowest levels since at least 1990 as speculation increased that the U.S. Treasury will have to bail out the mortgage-finance companies.

``To the extent that you get further unsettling news on the financial side, that will cause a turnaround and lead to more softening for the U.S. dollar,'' said Michael Gregory, a senior economist at the Bank of Montreal in Toronto.

Futures on the Chicago Board of Trade show a 18 percent chance the U.S. central bank will raise the 2 percent target rate for overnight lending between banks by at least a quarter- point by its Dec. 16 meeting, down from 34 percent odds a week earlier. Policy makers next meet Sept. 16.

To contact the reporters on this story: Kosuke Goto in Tokyo at kgoto2@bloomberg.net