The euro rose to fresh two-year peaks versus the dollar on Wednesday and within reach of its record high against the greenback after a strong German business sentiment index bolstered bullish eurozone interest rate expectations.
The dollar, meanwhile, weakened to its lowest level in two years against a basket of currencies after soft US housing and confidence data on Tuesday backed growing expectations that the Federal Reserve will cut borrowing costs this year.
The German Ifo business sentiment index for April was 108.6, just above a forecast of 108.0 and above the March reading of 107.7. The current conditions and expectations indices also beat forecasts.
Germany's government raised its 2007 growth forecast (for more, click on link, while analysts said the Ifo data set the seal on the European Central Bank raising rates to 4 percent in June.
"The German data was much, much better than expected and the ECB looks to be steady on a June rate hike," said Adrian Hughes, strategist at Societe Generale. At 1125 GMT the euro was steady on the day against the dollar at $1.3650, having touched a two-year peak earlier at $1.3656 and close to its all-time high of $1.3670 struck in December 2004 on electronic trading platform EBS.
The dollar index was at 81.435, after dropping to a two-year low of 81.365 earlier in the session. A move below 80.42 would mark its lowest since April 1995, according to Reuters data. The dollar was flat against the yen at 118.52 yen, staying in the tight 118-119 yen range it has clung to since late last week.
The euro traded around 161.68 yen, up 0.15 percent on the day and not far from record peak of 162.43 yen touched earlier in the month. Investors were looking for further insight on the monetary policy outlook, from US durable goods data and the Fed's Beige Book later in the day, with analysts saying weak figures could put further pressure on the dollar.
"If the Beige Book shows regional business investment slowing, companies may start to pare back hiring intentions which would be dollar-negative," said Chris Turner, head of FX strategy at ING.
Figures on new home sales will also be scrutinised as markets try to assess ongoing softness in the housing sector and whether that will translate into economic weakness. Analysts said that expectations on whether ECB rates will rise to 4.25 percent by year-end are now the key to determining how much further the euro can rise.
Data on Tuesday showed US existing home sales posted their biggest monthly drop in 18 years and consumer sentiment hit an eight-month low, fuelling speculation that the Fed may soon cut interest rates from 5.25 percent.
Market participants expect the central bank to wait until the second half of the calendar year to lift its overnight call rate from 0.5 percent, after raising it in February. Japan's Golden Week holidays next week were also keeping traders from placing significant positions in the yen.