The dollar will fall this year as the Federal Reserve keeps interest rates close to zero and the fiscal deficit stays near a record amid an extension of Bush-era tax cuts, according to JPMorgan Chase & Co.

The U.S. currency will be used to fund so-called carry trades, where it is used to buy higher-yielding currencies, said John Normand, the London-based head of currency strategy at JPMorgan. The dollar will slide about 12 percent to $1.48 per euro and 7 percent to 78 yen by the end of 2011, he said. The Canadian dollar may be the best performer among major currencies this year if oil averages above $100 per barrel, the bank predicts.

“U.S. growth alone cannot support the dollar as it’s highly unlikely that the Fed will be lifting interest rates in the next 12 months,” said Normand in an interview. “Few people will be buying the dollar as an investment vehicle. Many people will continue to use the dollar as a funding currency.”

The dollar gained 7 percent against the euro last year as investors sought refuge from a debt crisis that forced Greece and Ireland to turn to the European Union and the International Monetary Fund for bailouts. The greenback fell 13 percent versus the yen, its biggest decline against a major currency, as record-low interest rates in the U.S. reduced the attractiveness of American assets.

The dollar strengthened 0.1 percent to $1.2989 per euro and 0.2 percent to 83.50 yen as of 10:17 a.m. in London.

Tax Cuts

The Federal Reserve is unlikely to raise interest rates this year because inflation pressures remain subdued, Normand said. JPMorgan forecasts the U.S. economy will expand 3.3 percent this year, up from a 2.9 percent growth in 2010. Consumer prices will climb 1.2 percent, compared with an average of 2.5 percent in the past decade.

The dollar will underperform the 17-nation European currency as policy makers in the euro region work to reduce their fiscal shortfalls and the U.S. deficit widens following the extension of tax cuts implemented by President George W. Bush, said Normand.

The greenback will also suffer from a widening current account deficit, he said. The U.S. current-account gap, the broadest measure of trade, will rise to 3.4 percent of the nation’s output this year, while in the euro area it will drop to zero, according to economists in Bloomberg surveys.

Fiscal Deficit

“Given the EU leaders’ commitment to provide all necessary support to stabilize the region, pressures on the euro should fade as the periphery passed a refinancing hump in spring,” Normand said. “The market’s focus should then turn to the U.S. challenge of funding a 10 percent fiscal deficit and widening current account imbalance with zero cash rates, a backdrop which is dollar-negative.”

The U.S. deficit was $150.4 billion in November, exceeding the median estimate of economists surveyed by Bloomberg News, compared with $120.3 billion in November 2009, according to a Treasury Department budget statement released last month. The extension of tax cuts by President Barack Obama will expand the federal budget deficit to $1.34 trillion for fiscal 2011, Credit Suisse Group AG strategists estimated on Dec. 7.