Expectations the US Federal Reserve will stick to its aggressive stimulus programme pushed the dollar to a two-month low against a basket of currencies on Wednesday. The dollar index, which measures the US currency's value against a basket of currencies, dropped as low as 81.456, its weakest since late February. That helped the euro to a two-month high despite growing expectations the European Central Bank will cut interest rates on Thursday.
Soft recent data, including a survey on Tuesday showing an unexpected contraction in business activity in the Midwest, has sparked fears of a slowdown in the world's biggest economy. A weak reading for Institute of Supply Management's survey of US manufacturing activity, due at 1400 GMT, could intensify those worries, while Friday's US employment report will also be closely scrutinised by markets.
"We've seen a huge change in sentiment and the market is now of the view that the current (Fed) policy will be sustained," said Morgan Stanley currency strategist Ian Stannard. "The ISM could be important because if it is weak then that debate will pick up." The US central bank is expected to maintain monthly purchases of $85 billion in bonds when it announces a decision at 1800 GMT. Only a month or so ago, investors expected the Fed to start scaling back asset purchases.
"We think the Fed will be as dovish as it can afford to be, and as such the softness of the dollar is justified and if anything it could extend a bit further," said Adam Cole, global head of FX strategy at RBC Capital Markets. With the May Day holiday keeping Europe's markets closed, the euro rose 0.4 percent to $1.3223, its highest level since February 25, with traders saying it extended gains after breaking above a reported options barrier at $1.3200.
Traders and analysts said the currency's gains were likely to be limited, with a fall expected if rates are cut, although large options expiries reported at $1.3200 could keep it pinned around current levels. The pound also rose to its highest against the dollar since mid-February at $1.5591, helped by a better-than-expected UK manufacturing survey.
But the Australian dollar underperformed and was down 0.1 percent at $1.0353 after data showed growth in China's manufacturing sector unexpectedly slowed. The dollar was steady against the yen at 97.45 yen, having hit a two-week low of 96.99 yen the previous day.