The dollar fell versus the euro for the first time this week after the Federal Reserve reduced its discount lending rate to prevent credit market losses from slowing the economy.

The dollar weakened against 14 of 16 major currencies as a reduction in borrowing costs dims the allure of U.S. assets. The decline today trimmed the dollar's weekly advance as investors had sought safety in the currency after a global rout of credit markets. U.S. and European stocks rallied.

"The Fed has taken the first step to calm down the market and restore investors' confidence,'' said Tom Fitzpatrick, global head of currency strategy at Citigroup Global Markets Inc. in New York. "The dollar is getting a double-whammy. A reduction in interest rates makes it less attractive. The safe-haven flow into the dollar also flooded out.''

The dollar fell 0.6 percent to $1.3503 per euro at 1:20 p.m. in New York, from $1.3426 yesterday. The decline today trimmed the dollar's weekly gain to 1.4 percent against the euro.

The U.S. currency advanced to the highest in more than two months against the euro yesterday after banks and hedge funds scrambled to pay back loans in the dollar from their investments in riskier assets. Losses from U.S. subprime mortgages are spreading to global credit markets. The U.S. currency has rebounded from a record low of $1.3852 per euro on July 24.

The Brazilian real and Canadian currency led the advance against the U.S. dollar among the major currencies today, rising 3.5 percent and 1.4 percent, respectively. The dollar also fell 1.1 percent versus the South African rand, 0.7 percent against the Swiss franc and 1 percent versus the New Zealand currency.

Yen Declines

The yen fell against all 16 major currencies as the Fed's move encouraged investors to resume buying riskier assets funded by loans in Japan, in a practice known as the carry trade.

Japan's yen weakened 1.1 percent to 154.55 per euro and 0.5 percent to 114.46 per dollar. The Japanese currency also declined 1.8 percent versus the Canadian dollar, 2.2 percent against the Brazilian real, 2.5 percent versus the New Zealand dollar and 1 percent against the Australian dollar.

The losses in the yen today cut its weekly advance to 4.9 percent versus the euro as investors unwound carry trades over the past four days. The yen is up 3.5 percent against the dollar this week.

"The market got a temporary relief,'' said Samarjit Shankar, director of global strategy for the Global Markets group in Boston at Bank of New York Mellon. "But I don't think the unwinding of the carry trade is over. Investors' confidence still remains on shaky ground. There is still uncertainty about how many banks and funds are exposed to the subprime problem.''

5.75 Percent

The Fed cut the rate at which it makes direct loans to banks by 0.5 percentage point to 5.75 percent from 6.25 percent. The central bank, in an unscheduled announcement, said it's prepared to take further actions to "mitigate'' damage to the economy from the rout in global credit markets.

This is the first reduction in borrowing costs between scheduled Federal Open Market Committee meetings since 2001 and Ben S. Bernanke's first as Fed chairman.

"Financial market conditions have deteriorated, and tighter credit conditions and increased uncertainty have the potential to restrain economic growth going forward,'' the central bank's Federal Open Market Committee said in a statement released in Washington. "The downside risks have increased appreciably.''

Policy makers kept their benchmark rate, the federal funds rate target for overnight loans between banks, at 5.25 percent. It compares with 4 percent in the euro region, 5.75 percent in the U.K. and 0.5 percent in Japan, the lowest among major economies.

'Provides Some Calm'

"This temporarily provides some calm,'' said Meg Browne, foreign exchange strategist at Brown Brothers Harriman & Co. in New York. "It certainly is raising speculation that the Fed will cut the fed funds rate.''

Traders have increased bets that the Fed will cut its fed funds rate at the Sept. 18 meeting. The yield on fed funds futures contracts due that month reached 4.95 percent today from 5.1 percent a week ago and 5.245 percent a month ago. The yield suggests traders see a 100 percent chance the Fed will cut its benchmark rate by 25 basis points, up from 5 percent a month ago.

Volatility on one-month dollar-yen options fell to 16.2 percent from 17.8 percent yesterday. It earlier rose to as high as 23.5 percent, the highest since 1999. Lower volatility may encourage carry trades as it implies the bets will be exposed to smaller exchange-rate fluctuations.

The 10-year interest-rate swap spread, a gauge of what companies pay over benchmark lending rates, fell to 77.1 basis points, from 77.9 yesterday.

The yield premium on two-year U.S. Treasury notes over similar-maturity German bunds narrowed to 0.21 percentage point, from 0.27 percentage point yesterday. A smaller gap reduces the appeal of U.S. assets relative to those in the euro region.

The New York Board of Trade's dollar index comparing the U.S. currency against its six primary peers, including the euro and yen, fell to 81.324 from 81.729 yesterday and from an intraday high of 82.132 yesterday, the highest since June 29.