The dollar steadied on Tuesday, supported by growing expectations the Federal Reserve will raise interest rates next week and deepening uncertainty over an upcoming German election that capped the euro's rise.
Comments from Dallas Fed President Richard Fisher on Monday that the economic risks created by Hurricane Katrina would be temporary had bolstered the dollar as his remarks were taken to suggest the central bank would raise rates on September 20.
The yen had retreated on Monday from a week-high hit against the dollar after a landslide election victory for Prime Minister Junichiro Koizumi spurred hopes structural reforms would continue in Japan and entice more foreign buying of Japanese stocks.
"The market is tilting towards a view that the Fed will put more emphasis on inflationary pressures and raise rates next week, which is supporting the dollar," said Akifumi Uchida, a senior trader at Sumitomo Trust & Banking.
The dollar dipped against the euro as market participants covered short positions, but traders said the single currency's rise was capped amid jitters leading up to a tightly contested German election on Sunday.
Polls showed the lead held by Angela Merkel of the reform-minded Christian Democrat party over German Chancellor Gerhard Schroeder was shrinking in the final stretch of their campaigns.
"Risks leading up to the German election are going to pressure the euro, making more room for the dollar to gain," said Takehiko Jimbo, a forex dealer at Mitsubishi Trust and Banking.
The dollar was little changed at 110.35 yen, well above a low of 108.96 yen hit on Monday after Tokyo dealers had initially cheered the re-election of the market-friendly Koizumi.
The euro was up 0.2 percent at $1.2305, just short of the day's high around $1.2315. It bought 135.80 yen, up from around 135.60 yen in late US trade.
Japanese investor buying of the single currency for euro bonds help to weaken the yen across the board, said Uchida at Sumitomo Trust.
The market was eyeing data this week that could refocus attention on the huge US deficits, with current account deficit figures for the second quarter and capital flows data for July due to land on Friday.
Ahead of that, US trade deficit figures are due at 1230 GMT. Economists forecast the deficit deteriorated to $59.8 billion in July, which would be the second-largest level on record.
The increasing likelihood of an 11th-straight rise in US rates was seen dominating trade, particularly given that the post-hurricane impact on energy prices had not been as severe as initially expected, some dealers said.
Others argued that a rate rise was a shoe-in and was reflected in currency prices.