The dollar weakened broadly on Thursday, reversing a short-lived rally on news that China had raised interest rates as the market decided Beijing's move did not radically change dollar-bearish market fundamentals.
Comments by a European Central Bank monetary policy source that no intervention to curb the euro's strength will be forthcoming unless market moves become more "extreme" also lent support to the euro, analysts said.
"If those comments are true, they are significant," said Paresh Upadhyaya, portfolio manager with Putnam Investments in Boston. "I do think (the euro's subsequent bounce) makes sense. ... They (the ECB) may tolerate a move up to $1.30."
Echoing this apparently relaxed stance on euro/dollar, John Taylor, US Under-secretary for International Affairs, said on Thursday that recent moves in exchange rates have been "orderly and volatility has been low."
Both these remarks came after the market had settled down in the wake of China's first rate hike in almost a decade.
The dollar had initially rallied as dealers thought the tightening would adversely affect Asian and commodity-exporting countries, and that it might be instead of a yuan revaluation.
Dealers said the market's initial response to China's announcement was to buy back dollars that had been sold short in recent weeks.
But the dollar eased as most economists decided commodity exporters were unlikely to be devastated by declining demand. Traders also refocused on the factors that have been weighing on it recently, namely mixed US economic data, low US interest rates, a growing current account gap and uncertainty ahead of Tuesday's presidential election.
In addition, third quarter US gross domestic product data on Friday is potentially another reason not to hold dollars.
By late afternoon in New York, the euro was up 0.25 percent at $1.2737. The dollar was down half a percent against the Swiss franc at 1.2005 francs.
The currencies of commodity-exporting countries recovered smartly after an earlier pounding. The Australian dollar was up a touch at $0.7456 while the greenback was off around 0.2 percent against the Canadian dollar at C$1.2231.
The dollar was off slightly at 106.29 yen.
China's central bank raised the benchmark one-year yuan lending rate to 5.58 percent from 5.31 percent, and the rate on one-year deposits to 2.25 percent from 1.98 percent in an effort to cool its red-hot economy.
Pulling the monetary policy lever to cool the economy delays the moment when China pulls the lever on its controlled exchange rate policy, some analysts say.
China's yuan trades in a narrow band at around 8.28 to the dollar and is widely believed to be undervalued. Beijing has been under pressure from the United States and, increasingly, Europe, to adopt a more flexible currency regime.
US Treasury Secretary John Snow on Thursday said China's interest rate hike was consistent with a move toward a flexible exchange rate.
But an official at the International Monetary Fund said the rate hike was "not necessarily" connected to any shift in exchange rate policy.