The dollar rose against the euro Monday, boosted by year-end transactions and speculation of less aggressive Federal Reserve interest rate cuts after last week's strong U.S. inflation numbers.
While the Fed is expected to further ease monetary policy next year to shield the broader economy from housing market turmoil, analysts reckon lurking inflation pressures could see it taking measured steps.
This would not significantly erode the dollar's yield advantage, with other major central banks either expected to cut or keep interest rates steady on economic growth worries.
"We are just seeing a bit of follow-through from last week, where the dollar closed the week on a very solid footing against the euro, tripping a few technical levels for the market," said Stephen Malyon, currency strategist at Scotia Capital in Toronto.
"The market has reduced its Fed interest rate cut expectations so we have seen the dollar a little bit more interest (rate) supported in the last number of days."
In New York morning trade, the euro traded down 0.3 percent at $1.4370, after earlier dipping to 1-1/2 month low of $1.4332 in overseas trade.
The dollar index, which tracks the greenback's performance against a basket of currencies, touched a two-month high of 77.804 overnight, before retreating to 77.52, flat on the day.
Interest rate futures are pricing in a 78 percent chance of a quarter point interest rate cut at the Jan. 30 Fed meeting.
Analysts said year-end transactions were also behind the dollar's advance against the single currency.
"There are year-end considerations. There is position squaring and there is profit-taking following a year in which the dollar was under a lot of pressure," said Malyon.
The return of risk aversion as major central banks prepared to put into practice measures announced last week to help boost liquidity in cash-strapped money markets, pushed the dollar weaker against the yen.
The U.S. Federal Reserve is due to offer the first $20 billion of 28-day funds through its Term Auction Facility on Monday, with the European Central Bank and the Swiss National Bank also offering cash.
The dollar fell 0.1 percent to 113.24 yen also hurt by weaker U.S. equities as investors worried that rising inflation and signs of weak holiday retail sales would further darken the economic outlook for the world's largest economy.
News of an unexpected surge to $114 billion in U.S. long-term capital inflows in October, sharply higher than September's inflows of $15.4 billion, gave some support to the dollar, but analysts were a bit sceptical about the importance of the data.
"The dollar was weaker when all of these flows were occurring, detracting from the relevance in using this data as a rear view mirror indicator, not to mention its relevance for providing steer going forward," said Alan Ruskin, chief market strategist at RBS Greenwich Capital in Connecticut.