The euro hit a three-week high against the dollar on Friday, as investors focused on prospects for faster eurozone rate hikes after the US Federal Reserve signalled a pause in its long monetary tightening campaign.
As widely anticipated, the Fed raised interest rates for the 17th successive time to 5.25 percent on Thursday, but stirred financial markets by watering down its warnings about the need to tighten policy in the months ahead.
That, along with growing expectations that the European Central Bank could raise rates aggressively was holding down the greenback and boosting the single currency.
Euro zone inflation stuck at an annual 2.5 percent in June, beating forecasts for a fall to 2.4 percent, data showed on Friday. The European Commission's business climate indicator jumped to 1.41 this month, its highest in nearly six years.
This follows a run of strong data from the 12-nation block in recent days. ECB policymakers have also stepped up their rhetoric this week, warning of inflationary pressures.
"There seems to be talk doing the rounds today that the ECB could reach 3.5 percent by the end of the year, and I think that's probably adding to the interest rate spread argument for buying euros versus dollars, which got impetus from the Fed last night," said Adam Cole, senior currency strategist at Royal Bank of Canada Capital Markets.
By 1111 GMT, the euro was up 0.4 percent against the dollar at $1.2712, near a three-week high hit earlier in the session.
The dollar also hit a three-week low against an index of currencies at 85.47.
Building expectations that the Fed could raise rates to 5.5 percent in August had driven the dollar to two-month highs against major currencies in the past week. But it reversed gains on Thursday after the Fed's statement failed to support such a view.
The euro, meanwhile, rallied to two-month highs against the Swiss franc at 1.5687 francs and against sterling at 69.46 pence.
Investment bank J.P. Morgan on Friday said it had changed its forecast for eurozone interest rates, and now expects the European Central Bank to raise interest rates on July 6. The bank then sees rates in the eurozone rising to 4 percent by early 2007 from 2.75 percent now.
Against the yen, the dollar hit a one-week low of 114.47 yen on Friday after sliding more than 1 percent the previous day. The yen also managed to resist the euro's rally, staying steady at 145.74 per unit of the single currency.
Elsewhere disappointment after the Fed coupled with rallying commodity prices helped the New Zealand dollar rise one percent on the day to a one-week high versus the greenback and also took the Australian dollar to a two-week high.
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