The currency sank as low as $1.025 before recovering some ground. The drop followed news that headline inflation in the European Union climbed to 1.4 per cent in October from 1.2 per cent in September and 0.9 per cent a year earlier. Higher oil prices were the main reason for the increase, taking energy costs up by 6.4 per cent year on year. The "core" inflation measure (excluding oil and also food and alcohol prices), fell back from 1 per cent to 0.9 per cent.
"It is likely that oil prices will drive headline inflation higher still, but core inflation is very well contained," said Mark Cliffe, chief economist at ING Barings.
The European Commission is due to publish new economic forecasts on Wednesday, and is expected to stick to a forecast of 1.5 per cent for headline inflation in 2000. A spokesman for Pedro Solbes, the Economic Affairs Commissioner, said core inflation was "under control".
The European Central Bank raised its key interest rate by half a percentage point at the start of this month in order to contain inflationary pressures. The financial markets have pencilled in a further half-point rise during next year, but in its half-yearly "Economic Outlook" earlier this week the Organisation for Economic Co-operation and Development said there would be no need for an increase before the end of 2000.
Alison Cottrell at Paine Webber said: "The ECB's only concern will be that the wage round is moderate."
Mr Cliffe said changes such as telecoms deregulation in the main European economies would bear down on inflation.