Aug. 6 (Bloomberg) -- The dollar tumbled after U.S. employers in July created the fewest jobs this year, raising speculation the Federal Reserve will skip an increase in its interest-rate target at one of its meetings this year.

Within a minute of the Labor Department report showing the economy added 32,000 jobs last month, the dollar lost almost two cents against the euro and more than a yen versus Japan's currency. The median forecast of economists polled by Bloomberg News was for job creation of 240,000.

Investors "got caught on this one big time,'' said Enrico Caruso, chief trader at currency hedge fund Tempest Asset Management in Newport Beach, California. "A lot of people were expecting the numbers to be worse than the forecasts, but nobody was expecting it to be so bad. This raises serious questions about further rate hikes.''

Against the euro, the dollar had its biggest one-day drop since January, trading at $1.2247 at 10:30 a.m. in New York from $1.2054 late yesterday, according to EBS, an electronic currency- dealing system. The U.S. currency dropped to 110.10 yen from 111.61, and tumbled against the Swiss franc, the British pound and the Canadian dollar.

"The only thing ahead of us is the $1.2270 mark'' against the euro, Caruso said. "We might go there fairly soon. After that, it's straight to $1.24.''

The yield on September federal funds futures fell 4 basis points to 1.52 percent, signaling traders see a 24 percent chance the Fed will increase its interest-rate target to 1.75 percent at its Sept. 21 meeting. That's down from more than 70 percent yesterday.

Greenspan's Prediction

"This is definitely damaging to the dollar,'' said Jeremy Fand, senior proprietary trader in New York at WestLB AG. "You're taking away a 25 basis-point hike somewhere down the road.'' He said the dollar may decline to as low as $1.25 per euro next week.

Today's drop cut in half a 3 percent rally in the dollar since July 19, when Federal Reserve Chairman Alan Greenspan told Congress the U.S. economic expansion was "broad-based'' and creating jobs.

His prediction that a June slowdown would be "short-lived'' bolstered speculation the Fed would raise its 1.25 percent benchmark rate four more times before year-end, following a quarter-percentage point increase on June 30.

The European Central Bank's key rate is 2 percent and the Bank of England's is 4.75 percent.

"The interest-rate differential between U.S. Treasuries and local foreign bonds is narrowing dramatically,'' said Mark McFarland, director of currency strategy at UBS AG in London.

'Major Doubt'

The benchmark 10-year Treasury note yield sank 17 basis points, or 0.17 percentage point, after the employment report, to 4.23 percent. German 10-year government securities yield 4.07 percent, a gap that narrowed 10 basis points today.

Fed policy makers next meet on Aug. 10, and then Sept. 21, after which they have two meetings left in 2004.

A September rate increase "is in major doubt right now,'' said Samarjit Shankar, director of global strategy at Mellon Financial Corp.'s currency group in Boston. "It bodes ill for the dollar,'' because interest-rate expectations had been lending the currency support in recent weeks, he said.

The dollar fell about 1.3 percent on July 2, the day of the previous U.S. labor report, as June's job creation was less than half forecasts. It also dropped about 0.5 percent on June 4, after May's 235,000 in job gains, while beating the consensus forecast, fell short of some traders' expectations.

Dollar 'Headwinds'

Optimism the dollar would sustain a rally past $1.20 per euro dimmed on Wednesday, after an industry survey showed employment in services industries, which comprise about 85 percent of the U.S. economy, tumbled in July. Overall, service businesses still expanded last month.

"There's a number of headwinds for the dollar right now,'' said WestLB's Fand. "Unless we get consistently strong U.S. data it's very hard to quiet the headwinds.''

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