The dollar weakened on Wednesday as investors considered the greenback's recent rally to two-month highs had gone too far given the current outlook for US interest rates.
The US currency also gave ground against the yen as Japanese stock prices and bond yields surged after a top Bank of Japan official suggested Japan was closer to ending seven years of deflation and raising its own key interest rate.
With the Federal Reserve seemingly committed to raising US interest rates through the end of the year, the dollar is finding solid support, meaning its downside has been limited.
Still, future rate hikes may already be priced into the dollar, indicating some investors have overextended positions.
While the dollar made brief attempts early in the session to reach new highs against the euro and yen, selling pressure quickly pushed it back lower.
"The dollar gained as long as we had not priced in possible rate hikes in December and January," said Andreas Mann, New York-based principal at FrankfurtFX. "Now interest rate expectations are priced in and we are running out of a bit of steam."
The euro was up 0.2 percent at $1.2035, recovering from Tuesday's two-month low of $1.1976.
The euro had dipped as low as $1.1990 during the session but shot quickly back up to around $1.2055 before easing.
Michael Woolfolk, senior currency strategist at The Bank of New York, said he would not be surprised to see the euro move below $1.20 again but, equally, he would not be surprised to see euro buyers emerge again at these lows.
The dollar was down 0.1 percent against the yen at 113.10 yen. On Tuesday, it had traded as high as 113.50 yen.
A report on US durable goods orders for August, which did not capture post-Hurricane Katrina data, briefly arrested the dollar's decline on Wednesday.
Those orders rose 3.3 percent last month, compared with a downwardly revised 5.3 percent decline in July. Economists polled by Reuters had expected orders to rise by 0.8 percent.
Orders of non-defence goods excluding aircraft, seen as a proxy for business spending, rose a solid 3.6 percent.
Traders and analysts say US corporations repatriating funds to take advantage of a tax break before the end of the year also provided underlying support to the dollar.
Kansas City Fed President Thomas Hoenig said late on Tuesday that the US central bank must ensure price stability after the damage wrought by Hurricanes Katrina and Rita.
That echoed comments he made earlier in the week, and on Tuesday San Francisco Fed President Janet Yellen said allowing an unacceptable rise in inflation was not an option, signalling the Fed's 15-month streak of rate rises would not end soon.
The yen remains well bid after BOJ board member Miyako Suda said on Wednesday the days of the central bank's "quantitative easing" policy of flooding banks with cash were numbered.
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