The dollar recovered from an earlier 20-month low against a basket of currencies on Monday as investors locked in profits after shaving more than 3 percent off its value in less than two weeks.
The dollar has been under pressure as a run of weak US data has boosted expectations the Federal Reserve might cut interest rates next year. On Friday, the Institute for Supply Management's survey of US national manufacturing in November showed a contraction in the factory sector for the first time in 3-1/2 years.
In contrast, expectations for a European Central Bank rate hike this week and perhaps again in early 2007 have boosted the euro, sending it to within three cents of its record high versus the dollar and to a record peak against the yen on Monday.
Investors took advantage of the absence of major data or market-moving comments by policymakers to lock in profits from the dollar's recent sharp fall. "On a day without any news it's not too surprising that we see a bit of a setback for euro/dollar. But for the rest of the year we definitely see the euro gaining the upper hand," said Tobias Thygesen, senior analyst at Danske Markets in Copenhagen.
"Data out of the US has been mixed to say the least, while the data out of the euro area has been very positive and not even eurozone finance ministers could find themselves in a position to say that rates shouldn't go up given the strong euro," he added.By 1225 GMT the euro was down 0.15 percent on the day at $1.3316, off an earlier 20-month high of $1.3367. It is within a few cents of its 2004 record peak of $1.3667.
The euro hit a record high above 154.10 yen before falling back to 153.71. The dollar was steady at 115.41 after hitting a four-month low below 115 on Friday.
Sterling was off last week's 14-year high against the dollar, trading at $1.9782. The dollar slid to its lowest since March 2005 against a basket of currencies.
In line with recent upbeat data from the eurozone, the Sentix index on Monday showed that investor sentiment improved in December, with the current situation judged to be at its best since the survey began in February 2003.
Although French ministers have called for vigilance over the euro's rise, they have not been joined by counterparts from other eurozone states or by central bankers, prompting investors to conclude that $1.40 rather than $1.30 was now the key level that would make officials uncomfortable. The European Central Bank is expected to raise rates to 3.5 percent this week.
The Financial Times Deutschland reported on Monday that the ECB's staff inflation forecasts, due on Thursday, will likely be revised to 1.8-1.9 percent in 2008, below the bank's 2 percent target and thus implying less of a need to raise rates.
"When you look to Thursday, it looks like inflation forecasts will be revised down and the market may suspect that (ECB President Jean-Claude) Trichet may come across more dovish at the press conference ... The market may feel there could be a positive surprise for the dollar," said Steve Barrow, currency strategist at Bear Stearns in London.
Trichet is also speaking later on Monday in Madrid. In the United States, the pending home sales index for October is due at 1500 GMT. Federal Reserve Bank of Chicago President Michael Moskow speaks on the US economy at 1400 GMT.
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