The dollar wiped out some of last week's gains on Monday as geopolitical tensions resurfaced following bombings in Turkey and Iraq, sparking a sell-off in the US currency on heightened security fears.
Analysts said the dollar was also still hurting from fairly weak US economic data released on Friday, tempering some expectations the Federal Reserve was ready to raise interest rates. Such an increase would boost the dollar by making yields on US assets more attractive to foreign investors.
"There are still residual effects from last Friday's benign April CPI (consumer price index) report and disappointing May Michigan consumer sentiment index.
That tempered some of the market's aggressive outlook for US interest rate increases," said Alex Beuzelin, senior foreign exchange analyst at Ruesch International in Washington DC.
US April CPI rose 0.2 percent, lower than economists' forecasts for a rise of 0.3 percent, while the University of Michigan consumer sentiment index for early May came in at 94.2, below market expectations of a 96.5 reading.
"Compounding the dollar's defensive posture were the bomb attacks overnight in Turkey and Baghdad and that thrust geopolitical risk factors back to the forefront," he added.
The death of the head of Iraq's US-appointed Governing Council in a car bombing in Baghdad on Monday fuelled the sell-off in a market already jittery after four small bombs exploded in Turkey on Sunday hours before British Prime Minister Tony Blair arrived.
Attacks on Western interests sometimes trigger an exodus from dollar-denominated assets that could be vulnerable if attacks were to strike closer to the United States.
In late afternoon trade, the euro was up 1.25 percent at $1.2026. Against the yen, the dollar was trading slightly higher at 114.28 yen.
The dollar fell 1.5 percent to 1.2750 Swiss francs. Sterling gained 0.6 percent to $1.7692.
News that sarin was found in a shell that exploded in Iraq helped the dollar trim its losses, traders said.
"Initially, it was dollar positive," said Hugh Walsh, vice president of foreign exchange at Fortis Bank in New York.
He said that if the shell appeared to predate the US invasion of Iraq, it would help justify the military effort there. But if it were new, it would signal a renewed security risk, possibly posing a downside risk for the dollar.
The dollar had also drifted lower as traders digested a US Treasury report saying net capital inflows totalled $78.6 billion in March, down from February's revised $83.3 billion. Purchases fell slightly but net inflows remain robust.
"This report paints a mixed picture for US assets so far in 2004," said Sean Callow, currency strategist at IDEAglobal in New York.
"While foreign inflows again comfortably exceeded the US monthly current account financing requirement of around $42-44 billion, the massive foreign buying of Treasuries in March is not likely to be repeated any time soon," he said.