The dollar fell to a three-year low against the euro yesterday, as investors continued to lose confidence in US assets and expectations grew of an imminent Iraqi war.

The euro reached a high of $1.0539 in early trading, but fell back in the evening as the dollar received some support from rising US stocks before closing at $1.0507.

Mr Niall Dunne, financial markets economist with Ulster Bank, said the currency movements might have been exaggerated in thin markets, but noted a general level of comfort with current exchange rates.

He is expecting the euro to flutter around $1.05 or $1.06 until a conflict commences in Iraq, at which time he believes it could rise above the key technical resistance level of $1.07.

Mr Aziz McMahon, foreign exchange analyst with ABN Amro in London, agrees that the euro will retain space for upside movement as long as uncertainty about Iraq persists.

He considers a level of $1.09 to be achievable in the near term.

The move upward, which follows months of sustained dollar weakness, was welcomed by the president of the European Central Bank (ECB), Mr Wim Duisenberg.

Mr Duisenberg said a rising euro was positive as long as it helped to contain inflation.

The ECB decided yesterday to maintain its course on euro-zone interest rates against a backdrop of stagnant growth in the 12-currency area.

New data from the EU's statistical agency show that the euro zone posted GDP growth of 0.8 per cent in the third quarter of 2002 when compared with the same three months of 2001.

The ECB's Governing Council said it had decided to maintain the euro-zone's key interest rate at 2.75 per cent because it was "appropriate" for keeping inflation in check.

The path was left open to a further rate cut in the near future however, with the bank emphasising the downside on economic conditions in the euro zone.

In a statement, council members said the economic outlook remained uncertain and was open to a number of risks.

Geopolitical tensions "continue to weigh adversely on confidence", according to the bank.

The council highlighted the recent upswing in oil prices as a possible prelude to more acute tensions in the oil markets which could have an negative impact on global economic activity.

Acknowledging that oil price movements made predictions on inflation difficult, the council forecast a stabilisation below 2 per cent in coming months.

Euro-zone inflation was running at 2.2 per cent in December, more than twice the rate recorded in the Republic.

Wage inflation must be checked if overall price stability is to be achieved, the bank has warned.

According to Mr McMahon, the tone of the comments suggested that the ECB could be preparing markets for an interest rate cut of 50 basis points as soon as March, as the institution sought to build on December's reduction.

However, Mr Dunne believes the cut will be delayed to April or May, and may be limited to 25 points.