The dollar rebounded against the euro and sterling on Tuesday and pared losses versus the yen after a report showing the U.S. service sector grew at its fastest pace since May countered signs of slower U.S. growth.
The rise in November service sector activity surprised the market, which expected a much weaker reading after a recent spate of soft U.S. data, including a report showing factory output last month contracted for the first time in 3-1/2 years.
The data put the brakes on a sharp dollar slide that began in late November and cast doubt on the view that the Federal Reserve will cut interest rates in early 2007.
"The services data was a critical number. It creates a lot of murkiness about what the U.S. economy is going to do next," said Tim O'Sullivan, chief trader at Forex.com in Bedminster, New Jersey.
Midafternoon, the euro was close to its New York closing level on Monday, after having slipped as low as $1.3288 after the data. The euro had moved as high as $1.3367 on Monday.
Sterling was also well off a 14-year peak above $1.98
The dollar has lost some 3% of its value over the past couple of weeks amid a flurry of soft U.S. data and expectations of higher interest rates in the euro zone at a time when the Fed could be forced to trim U.S. rates.
But Forex Capital Market strategist Boris Schlossberg said the market was "grossly oversold," adding that Tuesday's services report created a near-term "ceiling" for sterling and the euro, the two biggest gainers against the dollar.
The dollar trimmed losses against the yen still down on the day but above a four-month low at 114.44 yen hit overnight.
Japanese rates at 0.25 percent have kept the yen under pressure and facilitated carry trades in which investors borrow cheaply in yen to buy higher-yielding currencies.
Softer data out of Japan has dimmed expectations of a BOJ rate rise this year but O'Sullivan said the yen's exchange rate, along with uncertainty over the strength of the U.S. economy, is another wildcard complicating things for currency traders.
"There are a lot of people long dollar, short yen, and if they start to unwind those carry trades, you're going to see the dollar fall to 111 or 112 yen pretty quickly," he said.
For now, though, the U.S. service sector report "pretty much squashes any chance of a serious dollar sell-off before the nonfarm payrolls data on Friday and will probably restrain volume," said Alan Ruskin, chief international strategist at RBS Greenwich Capital in Greenwich, Connecticut.
The U.S. will release its payroll report on Friday, with the market looking for a gain of 110,000 jobs in November, above the prior month's 92,000 tally.