Aug. 20 (Bloomberg) -- The dollar fell to a one-month low against the yen in Asia as record oil prices reduced expectations the Federal Reserve will raise interest rates next month.

The Fed last week raised its benchmark rate and said higher energy prices were partly responsible for a slowing economy. Leading indicators fell and manufacturing growth in the Philadelphia region slowed, reports yesterday showed. By contrast, Japan's service industries expanded more than forecast, a report in Tokyo showed.

"The rise in oil prices is hurting both the U.S. and Japan,'' said Takuro Kanaoka, market strategist in Tokyo at Mitsubishi Trust & Banking Corp. "But looking at the recent U.S. and Japanese data, you have to say sentiment isn't favorable for the dollar.''

Against Japan's currency the dollar dropped to 109.05 yen at 11:59 a.m. in Tokyo from 109.35 late yesterday in New York, the weakest since July 21, according to electronic currency-trading system EBS. Against the euro, it traded at $1.2369 from $1.2364.

The yield on the September fed funds futures contract is 1.56 percent, indicating traders see about a 72 percent chance of a 25-basis point increase to 1.75 percent at next month's meeting. At the end of July, fed funds futures were signaling a 90 percent chance of such a move.

'Another Drag'

The Fed's Philadelphia index fell to 28.5 from 36.1 in July. Economists polled by Bloomberg expected a reading of 30. The Conference Board said its leading economic indicator index declined for a second month in July, dropping 0.3 percent, from a revised 0.1 percent drop in June. A Bloomberg survey showed the median forecast was a 0.1 percent fall.

Crude prices have risen 9.8 percent since helping the dollar drop 1.1 percent against the euro and 2 percent versus the yen.

"With the softer numbers we're seeing in the U.S., the Fed is going to view oil as another drag on growth,'' said Harvinder Kalirai, head of market research in Sydney at State Street Corp., the world's largest custodian of assets. "Interest rate expectations are diminishing, and that's bad for the dollar,'' which may fall to $1.30 per euro by year-end.

'Give Up Gains'

The yen may weaken against the euro as Japanese stocks declined for the first day in four, raising concern demand from overseas investors will slow. The Nikkei 225 fell as much as 0.6 percent, paring its advance this week to 0.8 percent.

Japan's currency traded at 134.91 per euro, from 135.29 in New York yesterday, a gain of 1.4 percent for the week.

The currency also may weaken on renewed speculation higher energy prices will slow the Japanese economy. Japan, which imports virtually all its oil, is the world's third-largest consumer of petroleum.

"It's hard to be confident about Japanese equities right now,'' said Robert Rennie, currency strategist in Sydney at Westpac Banking Corp. "And with oil at these levels, you have to think the yen will give up its gains, especially against the euro.''

The yen still headed for its second winning week in three against the dollar after a report showed Japan's service industries expanded more than forecast.

The tertiary index, a measure of demand for services, rose 0.8 percent in May, the Ministry of Economy, Trade and Industry said. The median estimate of 31 economists surveyed by Bloomberg News was for a 0.4 percent increase. The Nikkei headed for its first weekly gain in three.

'Serious Issue'

Crude oil futures rose to a record $48.90 a barrel in electronic after-hours trading on the New York Mercantile Exchange. They will probably rise next week, after setting records every day except one since July, on concern shipments will be curtailed as demand grows, a Bloomberg survey of traders and analysts showed.

Thirty-two of 51 respondents, or 63 percent, predicted the price rally will continue next week. Prices have surged 50 percent this year on concern exports from Saudi Arabia, Russia and Venezuela may be disrupted.

Treasury Secretary John Snow said in an interview the increase in energy prices is a "serious issue.''

"Current energy prices have slowed the economy down somewhat,'' Snow said. "The oil story is affecting the market psychology and it's creating an overhang in the market that's clearly unwelcome and clearly negative.''

Restrained

The Fed statement on Aug. 10, which accompanied a quarter point rate increase to 1.5 percent, said economic "softness likely owes importantly to the substantial rise in energy prices,'' the first time since May 2003 it has mentioned such concerns.

U.S. Treasury 10-year notes rose close to a four-month high yesterday as speculation grew the Fed will curb the pace of interest-rate increases.

"We have seen the U.S. treasury market rally and clearly the market is seeing the rise of oil prices affected there, which may restrain the degree of tightening by the Fed,'' said Greg Gibbs, a Sydney-based currency strategist at RBC Capital Markets. "That could be argued somewhat negatively for the U.S. dollar.''

In other trading, the British pound bought $1.8334 from $1.8317 a loss of 0.5 percent this week. The Swiss franc held at 1.2424.

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