The dollar rose against the euro as comments by European Central Bank President Jean-Claude Trichet increased uncertainty over how much more the gap between U.S. and euro zone interest rates could narrow and ahead of key U.S. jobs data on Friday.
The yen also fell, retreating from recent highs against both the dollar and the euro, as a rate hike in Europe and a rebound in global stocks prompted investors to sell the yen to buy higher-yielding assets.
Following the ECB's decision to raise its benchmark interest rate to 3.75%, Trichet said rates in the region were moderate and monetary policy was on the "accommodative side." In the past Trichet has described euro zone rates as low.
"Trichet is not as hawkish as markets expected," said Steven Butler, director of currency trading at Scotia Capital in Toronto. "That took the euro lower."
The euro was trading near session lows against the dollar down 0.4% compared with around $1.3150 before Trichet's remarks.
The dollar was up around 1.3%, on pace for its biggest daily advance against the Japanese currency since October 2006. The euro was trading 0.7% higher against the yen.
Investors are now awaiting the U.S. employment report on Friday, with any weakness in the data seen stoking expectations that the Fed would cut interest rates later this year, which analysts said may temper Thursday's drop on the euro.
"Logic suggests a limit on the downside (for the euro) once attention shifts to the U.S. employment report on Friday," said Jay Meisler, principal of Global-view.com, an online forum for
investors and dealers.
The median forecast among economists polled by Reuters is for a gain of 100,000 jobs in February, while other data has raised speculation that the figure could be weaker.
The yen had surged in the past week as doubts about the U.S. economy and a broad equities sell-off triggered heavy unwinding of carry trades in a bid to limit exposure to riskier positions.
But a rebound in stock markets and interest rate hikes have made investors more comfortable with taking on the risk of borrowing the low-yielding yen to invest in higher-return assets.
Earlier on Thursday, the Reserve Bank of New Zealand hiked its official interest rate to 7.5%, further widening the yield gap versus other industrialized countries. The New Zealand dollar rallied across the board, adding about 1% versus the U.S. currency.
Elsewhere, sterling erased earlier gains versus the dollar after the Bank of England held rates at 5.25% as expected, disappointing a minority who had been speculating about the possibility of a surprise rate hike.
Further ahead, investors are awaiting a U.S. payrolls report on Friday, with any weakness in the data seen stoking expectations for the Fed to cut interest rates later this year, which analysts said may spark dollar selling against the yen.
A Reuters poll shows expectations for the addition of 100,000 new jobs in February, while other data has raised speculation that the figure could be weaker.