The dollar fell on Tuesday, pausing for breath following gains in the past few days as investors assessed the likelihood of an earlier-than-expected interest rate hike in the United States. The euro climbed, reversing losses suffered after an unexpected fall in German industrial output.
The data initially sparked selling in the euro, pushing it roughly to the day's low as it added to the view that the eurozone's biggest economy remains weak.But the euro recovered to hit the day's high, with some analysts citing rising share prices boosting demand for risky trades. European shares traded half a percent higher by 1225 GMT.
The dollar had climbed after optimistic US jobs data late last week stoked the view that US rates may rise from roughly zero at the end of 2009. But its rally had fizzled by Tuesday as a lack of major economic data or events left traders with few reasons to push the dollar higher.
Analysts said the dollar's move in the past few sessions suggested that monetary policy issues may become a driver of currency movements in the near future, after market participants have focussed on risk appetite for much of the year.
"The dollar's general trend was to weaken on strong data (but US) payroll figures on Friday saw a reverse of that," Steve Barrow, head of G10 FX research at Standard Bank said. "The market may think that is a sign that markets will focus back on prospects of monetary policy rather than prospects for stock markets as a consequence of economic data," he said.
Traders said they were focusing on economic indicators and auctions for US debt later this week to gauge whether a shift towards a dollar-positive trend will take hold. A rise in sterling also added to downward pressure to the dollar, as house prices in England and Wales in the three-months to May fell at their slowest annual pace in 1-1/2 years.
Sterling rose 0.7 percent to $1.6172 as traders drew relief as the political storm engulfing UK Prime Minister Gordon Brown appears to have calmed for now. The euro traded 0.6 percent higher at $1.3987, recovering from lows hit after data showed German industrial output fell by 1.9 percent month-on-month in April.
Despite the data, which was much weaker than economists' expectations for a 0.1 percent rise, the euro recouped some of its losses made on Monday when Standard & Poor's downgraded its sovereign rating on Ireland. Still, the possibility of more Irish downgrades remained, with ratings agency Moody's saying on Tuesday it was concerned about Ireland and would conclude the review of its AAA rating after a visit to Dublin in the coming weeks.
Some in the market said that the view that Latvia may not have to devalue its currency to deal with extreme economic weakness also provided some support to the euro. The US dollar fell 0.5 percent against a basket of currencies to 80.428, below 81.466 hit on Monday for the first time since May 20. The dollar fell 0.4 against the yen to 98.05 yen. Data last week showed the pace of US job losses slowed sharply in May, sparking talk that the Federal Reserve may raise rates later this year and boosting the dollar.