The dollar pulled back after hitting a two-month high against a basket of currencies on Monday, with market players taking profits after scoring big gains on data late last week showing a jump in US consumer inflation.
In early trade the dollar extended its broad rise after a report showed US consumer prices surged in November by the most in two years, prompting investors to see less chance of a Federal Reserve interest rate cut in January. The surprising acceleration in inflation drove the dollar to its biggest one-day rise against the euro in three years on Friday.
The high-yielding currencies were hit by a broad selling in Asian stocks, with the benchmark Australian index falling 3.5 percent to a three-month closing low. The Nikkei fell 1.6 percent
The dollar was also weighed down by Japanese exporters selling the dollar above 113 yen, but traders said the dollar's upside appeared bigger than the downside in the near-term. "The dollar's rebound has more legs," said Sharada Selvanathan, a currency strategist at BNP Paribas in Hong Kong.
"On the one hand, the market is heavily short dollars, so positioning favours a rebound. Second, if risk sentiment fails to improve from today's auction, then a flight to safety will be dollar positive," she said. Activity was subdued as some market players refrain from taking big positions in the waning days of 2007.
Investors have unwound hefty bets against the US currency before the year-end, helping it bounce back from this year's broad tumble to record lows against the euro and a 26-year trough versus the pound in November. The euro rose 0.1 percent from late US trade on Friday to $1.4436 recovering from a seven-week low of $1.4382 on trading platform EBS in early trade.
The dollar eased 0.3 percent to 113.03 yen but was near a five-week high of 113.60 yen reached on Friday. The dollar index, a gauge of its value against six major currencies, slipped 0.3 percent to 77.327 after climbing to a two-month peak of 77.585 in early trade. The Australian dollar was little changed at $0.8610 but down 0.3 percent against the yen at 97.300.
Investors are now looking to see how this week's co-ordinated funding auctions by the Fed, the European Central Bank and other central banks work to ease the severe squeeze in money markets at the year-end. The Fed cut overnight rates last Tuesday by a quarter-point to 4.25 percent and has slashed them a full percentage point since September, but investors are now less sure if another policy easing is coming as soon as next month.
Central banks in Canada and Britain have followed the Fed in cutting rates to limit the economic and financial market fallout from this year's credit crunch. Now the Fed, the ECB and the Swiss National Bank are working in conjunction with those two central banks to provide funds and relieve the strains in money markets.
The Fed will sell $20 billion of 28-day loans to banks and other financial institutions on Monday, with results of the offer coming on Wednesday and settlement on Thursday. The ECB is offering $10 billion over the same period.
Since the joint operations were announced last week, one- and three-month interbank lending rates for dollars, euros and pounds have come down slightly but remain well above overnight rate targets.