The euro dropped against the yen and the dollar on Wednesday after the European Central Bank gave no clear indications about the outlook for interest rates beyond 2007, while global equity market weakness helped lift the Japanese currency.
The yen was on track for the largest daily increase against the dollar in nearly two months, with investors exiting risky trades funded by borrowing cheaply in yen after seeing stock markets around the world weaken.
The ECB lifted its benchmark lending rate to 4 percent, but the quarter-percentage-point hike had been well telegraphed and failed to boost the euro, which has been rising along with European interest rates over the last year.
While ECB President Jean-Claude Trichet said liquidity remains ample and inflation risks remain tilted to the upside, he added the ECB does not intend to alter its 2008 inflation forecast.
"Some investors were expecting too much out of the ECB's announcement. They wanted an aggressive indication about further rate hikes, but in the end, the ECB did not offer that," said David Durrant, chief strategist at Julius Baer Investment Management in New York.
The euro fell around 0.35 percent from late Tuesday to 163.47 yen. It had risen to a record high on Tuesday of 164.62, according to electronic platform EBS. Equity weakness prompted investors to unwind trades financed by borrowing yen at low Japanese interest rates, a strategy known as the carry trade, analysts said.
The Morgan Stanley Capital International gauge of world stock markets fell about 1 percent, the largest single-day decline in a month. Investors in interest rate futures have nearly priced out any chance of the Federal Reserve cutting rates this year after data has pointed to surprising strength in the US economy.
Meanwhile, euribor contracts rallied across the 2008 part of the curve after Trichet's remarks, with the implied chances of euro-zone rates hitting 4.5 percent by March falling to around 60 percent, from 80 percent a day ago.
The euro slipped below $1.3500 to a session low of $1.3486, down 0.2 percent from late Tuesday and nearly two cents from a record high above $1.3680 hit in April. It last traded around $1.3506. The euro hit a one-month low at 1.6423 francs.
"It seems the ECB is going to hold off for a while, and the euro will have a tough time getting through $1.36 again soon," said David Hilgeman, an analyst at optionsXpress in Chicago. At 4 percent, euro-zone interest rates are at their highest in nearly six years and are double what they were 18 months ago, when the ECB began its current monetary tightening cycle. The yen also gained ground on the dollar, which fell 0.3 percent to 121.05 yen.