The U.S. greenback surged Friday, capping off the biggest weekly dollar rally in three and a half years, as the euro slumped on speculation the European economy would continue to weaken.

The euro fell as low as $1.5008 Friday afternoon, dropping more than 2% from $1.5325 Thursday – the biggest one-day drop since Sept. 6, 2000. Against the yen, the European currency traded at 165.84, from 167.70. In the dollar rally, the euro has declined 3.1% against the greenback in its fourth weekly decline.

In addition to rising against the euro, the greenback climbed 0.5% to 109.97 yen after touching 110.08, the strongest since Jan. 10, Bloomberg News reported. The U.S. currency advanced 2.1% in its biggest weekly gain since June.

“This is the beginning of a new chapter for the dollar as [ECB President Jean-Claude Trichet] and other central banks are paying more attention to the downside risk to growth,” said Dustin Reid, a senior currency strategist at ABN Amro Holding NV (OTC ADR: ABNYY), told Bloomberg. “The decline of oil prices is a significant driver behind this dollar rally because it enables other central banks to turn their eyes away from inflation and focus on growth.”

Trichet said Thursday that while growth would be “particularly weak” in the second and third quarters, inflation is “likely to remain well above levels consistent with price stability for a protracted period of time.”

European retail sales dropped by the largest margin in at least 13 years in June, sliding 0.6%. Business and consumer confidence plunged in the 15 countries using the euro in July, as the EU’s economic sentiment indicator fell to 89.5 – the lowest level since March 2003 and the sharpest month-to-month drop since October 2001.

Italy’s economy unexpectedly shrank in the second quarter, coming closer to its fourth recession in a decade. The economy, contracted 0.3% after expanding 0.5% in January to March.

It’s likely that Germany’s economy is shrinking as well. Germany’s factory orders for June fell 2.9% in June, after a 1.4% decline in May, leading economists to speculate that economic growth in Europe’s largest economy is contracting.

The German economy contracted by 1% in the second quarter, and Eurozone growth may was flat at best, economists at BNP Paribas SA (OTC: BNPQY) said in a research note.

Dire growth prospects outside the United States have also lead to a steep drop in commodities prices. Oil plunged $4.82, or 4%, settling at 115.20. Oil has now plummeted more than 20% from its July 11 record of 147.27. Gold fell $15.50, or 1.77%, Friday to $862.40 an ounce. The prices of other metals and crops sank as well.

“The dollar is, in my view, in a genuine recovery,” Stephen Jen, global head of currency strategy at Morgan Stanley (MS) in London, told Reuters. “This trend could run further than many think,” said.

Source: Turbulence in the European Economy Sparks a Dollar Rally