The head of the IMF warned that a growing drive by nations to cap the strength of their currencies risked derailing economic recovery while the dollar dropped further on Wednesday.

Concerns that the U.S. Federal Reserve is about to embark on another round of policy easing that could weaken the dollar,tallied with China's polite refusal to let its yuan rise fast,has pushed currencies to the top of the agenda at Friday's meeting of finance chiefs from the Group of Seven nations.

Few hold out much hope of any meaningful agreement at the G7or the International Monetary Fund meeting that follows.

"It's doing nothing for the American economy, but it's causing chaos over the rest of the world. It's a very strange policy that they are pursuing," Nobel economics laureate Joseph Stiglitz said of U.S. policy.

The dollar extended its losses on Wednesday, falling to an8-1/2 month low against a basket of currencies and edging towards a 15-year trough versus the yen.

That trend prompted Japan to intervene to weaken the yen last month and some emerging economies have followed suit or are threatening to.

"There is clearly the idea beginning to circulate that currencies can be used as a policy weapon," IMF Managing Director Dominique Strauss-Kahn was quoted as saying in Wednesday's edition of the Financial Times.

"Translated into action, such an idea would represent a very serious risk to the global recovery ... Any such approach would have a negative and very damaging longer-run impact," he said.

The IMF, which holds its twice-yearly meeting in Washington this weekend, is also expected to discuss foreign exchange moves as part of its mission to get countries working for balanced global growth.

Brendan Brown, economist at Mitsubishi UFJ Securities International in London, said the Fund, which has the United States as its biggest stakeholder, would not try to prevent further U.S. monetary easing or a resulting slide of the dollar.

"That Washington institution has failed in its central mission to prevent currency war," he wrote in a report.

CHINA UNMOVED

Euro zone policymakers urged Chinese premier Wen Jiabao on Tuesday to allow the yuan to rise more rapidly, but he politelyre buffed them, repeating Beijing's standard line on seekingcurrency stability.

Wen was due to hold a joint news conference with EU leaders in Brussels at 1515 GMT.

Policymakers have highlighted the issue of global im balancesfor years, with fundamental problems seen as the dollar's global dominance, China's overvalued yuan and Germany's lack of domestic consumption.

Emerging nations say the cash flows seen this year have damaged their exports due to the determination of major economies to restrain their own currencies' levels.

But entrenched positions make it unlikely that officials sitting down to IMF and G7 meetings this weekend, and G20meetings later in the year, will resolve their differences.

Brazil fired the latest shot in what it has dubbed an"international currency war", doubling on Monday a tax on foreign investors buying local bonds to 4% to curb a strong real.

Policymakers from emerging Asian economies have voiced growing concerns about the risk of a flood of hot money in flows.South Korea warned investors it might impose further limits on forward trading and India and Thailand said they were looking at steps to control speculative surges.

"It's natural in that context for them to say -- we can't just let our exchange rates appreciate and destroy our exports,"Stiglitz told reporters at Columbia University on Tuesday.

MORE FED EASING?

Adding to speculation that the Federal Reserve will soon extend asset purchases to pump money into the economy, Chicago Fed President Charles Evans was quoted as saying the centralbank should do much more to spur the economy.

And in a surprise move, Japan pulled interest rates on the yen back to zero on Tuesday and pledged to pump more funds intoan economy struggling to compete while the currency remainsclose to a 15-year high against the dollar.

The euro gained 7.6% versus the dollar last month as Fed easing speculation hotted up. Europeans are worried they will be saddled with an overvalued currency, stifling recovery,because they have few tools to contain the euro's  rise.

France, which takes over the presidency of the Group of 20major economic powers next month, has put reforming the international monetary system at the top of its agenda, hopingto draw China into multilateral talks on currency coordination.