The dollar hovered near a two-week low against the euro on Friday after the European Central Bank voiced concerns about inflation and as traders hesitated to bid up the dollar on worries about upcoming US employment data.
The dollar posted its biggest one-day loss versus the euro in over three years on Thursday as investors sold the currency partly on the view its recent rally on expectations for higher US interest rates had been overdone.
"Comments from the ECB's Trichet were a bit of a surprise so the dollar's adjustment was deeper," said Kikuko Takeda, market economist at Bank of Tokyo-Mitsubishi, adding the currency was unlikely to decline much further.
"Given the euro zone's structural problems, such as high unemployment, the ECB is unlikely to raise rates repeatedly like the Fed," she said, suggesting the dollar's rate advantage would stay intact.
The euro, which also hit a two-month high around 138.20 yen on Friday, was given a lift by comments from ECB President Jean-Claude Trichet.
After the ECB left its key rate unchanged as expected on Thursday, Trichet said that strong vigilance against inflation was essential and the central bank was ready to raise rates should problems worsen.
The market's immediate focus is on US payroll data due at 1230 GMT. Economists surveyed by Reuters expected to see a loss of 143,000 jobs in September as layoffs in the wake of Hurricane Katrina seep into nation-wide figures.
The euro was down slightly at $1.2165, off a two-week high of $1.2205 hit in US trade and well above the three-month low of $1.1900 struck earlier in the week.
Growing hopes that German Chancellor Gerhard Schroeder's Social Democrats and Angela Merkel's conservative Christian Democrats are finally moving towards forming a "grand coalition" also helped the euro, traders said.
The dollar bought 113.45 yen, up slightly from late US levels but about one yen below the 16-month high of 114.41 yen hit this week.
Sterling was at $1.7760 after climbing as far as $1.7814 in US trade - its highest level in more than a week.
"It's an adjustment. It's not that the market thinks the Fed will stop raising rates," said Fumihiko Kawano, forex manager at Nomura Securities.
"But how long the adjustment is going to last, we'll have to see."