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The dollar stepped back from an earlier two-year high against the yen and three-month peaks versus the euro in volatile trade on Wednesday after investors locked in profits after the greenback's two-week strong rally.
Comments from a top Federal Reserve official signalling more interest rate hikes and a break of an option-related key technical level around $1.19 triggered a bout of dollar buying in early European trading.
But the dollar later erased losses, with dealers reporting sizeable euro buying from Middle Eastern and Asian central banks looking to diversify their reserves into the single currency.
"There has been talk of European and Asian central banks buying euros every time we hit $1.19-$1.1920/30 - we got there last week and again today. Probably short-term players got taken out today," a US bank trader said.
A British bank trader said: "Loads of Middle Eastern and Asian central banks were buying euros on the break below $1.19. The market got short."
By 1130 GMT the euro recovered to $1.1967, up slightly on the day. The euro fell to a three-month low of $1.1876 earlier in the session, compared with the month's high of $1.2206.
The dollar was down 0.3 percent against the yen at 115.33 after rising to a two-year high around 116 yen.
It also hit a three-month high against the Swiss franc earlier before pushing back.
Speculation of central bank bids tends to emerge when the euro falls below $1.20 - seen as attractive levels for reserve managers to buy the single currency.
Wednesday's talk comes as Ukraine's economy minister said in an interview with Reuters on Tuesday the country has been diversifying its FX reserves into the euro, sterling and the Swiss franc.
Fed Vice Chairman Roger Ferguson said on Tuesday the energy price surge following hurricanes Katrina and Rita had worsened the inflation outlook but the economic prospects remained solid.

Copyright Reuters, 2005

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