Despite a brief lift from the war in Iraq, the U.S. dollar is once again facing negative fundamentals and should continue to weaken in the coming year , BMO Nesbitt Burns Inc. says.

“The U.S. dollar remains in full retreat, and there seems little standing in the way of further depreciation.,” BMO said in report Thursday. “ We look for the US$ to weaken further in the year ahead, undercut by some of the lowest yields in the world and a huge current account gap that threatens to widen amid weak global growth.”

BMO said it has raised and pushed out its target high on the euro, which it now expects will hit US$1.20 by the middle of next year. BMO said the European economy has little going for it right now, but investors are searching for yield as well as a liquid alternative to the sagging US$. “We look for the U.S. economy to rebound in the quarters ahead, and to easily outpace Euroland growth, and this could provide some temporary support for the greenback. However, the underlying trend will continue to be dollar depreciation.”

BMO noted the yen was one of the few currencies in the world that did not surge against the U.S. dollar last month, dampened by the slide in the Nikkei to 20-year lows and renewed concern over the Japanese economy. “We remain even more bearish on the yen than the greenback, and we have left our call on the yen largely unchanged – the currency is expected to weaken to around the ¥124 level over the next year.”

Even with some softness in resource prices recently, the commodity currencies have caught fire again, BMO said, noting the Canadian dollar has leapt 10% since the start of the year, while the Australian dollar has soared over 11%.

“These currencies are buoyed by relatively generous yields, respectable growth prospects, and positive fundamentals,” BMO said. “For Canada, the election of the Liberals in Quebec removes one thorn for the loonie, and the SARS outbreak is likely to cause only a single-quarter hit to domestic growth. While the Bank of Canada has toned down the hawkish rhetoric a notch, Canada/US spreads are expected to remain attractive and could widen a bit further. Accordingly, we have boosted our one-year target to 73¢ (or $1.37/US$).”