The dollar rose Wednesday, shrugging off worries of a U.S. recession, as investors started to focus on a potential growth slowdown in the euro zone after dour German industrial output and retail data.
A slower growth pace in the common monetary area would force the European Central Bank to abandon its hawkish inflation rhetoric, denting the euro, analysts said.
"Markets are starting to price in problems for the euro. We saw further weak data out of Germany today that further fueled that type of bet,' said David Gilmore, partner at FX Analytics in Essex, Conn.
"Markets had plenty of time to price in bad news for the U.S. and even a recession, and are yet to price in much of any problem for the European economy. Markets are starting to realize the notion of decoupling is not going to be valid."
German industrial output, exports and retail sales all fell in November, heightening concerns about the outlook for growth in Europe's largest economy.
In New York afternoon trade, the euro was down 0.4 percent at $1.4650, after dipping to a session low of $1.4640.
The dollar was up 0.5 percent at 109.45 yen, shrugging off a drop in U.S. equities. It earlier touched an intraday peak of 109.71 yen.
"It's not as easy as it was in 2007 when you could sell the dollar against any currency, except the yen, and do quite well," said Gilmore.
Analysts said the dollar's resilience in the wake of December's dismal jobs report had left some investors reluctant to continue selling the greenback and start betting on its retracement against the euro.
Road to Recovery
The dollar's gains on Wednesday came even as Federal funds futures were pricing in a roughly 80 percent chance of a half percentage point reduction in the Fed's benchmark overnight lending rate to 3.75 percent at month end, while a 25 basis point cut has been fully factored in.
"The sentiment seems to be that aggressively cutting interest rates now is necessary and the sooner the cuts the sooner the U.S. economy will be on the road to recovery, perhaps in the second half of this year," said Paul Lennox, corporate treasurer at Custom House in Victoria, British Columbia.
"Many analysts are calling for a stronger dollar in the second half of the year and traders seem to be thinking selling dollars now is not the high probability one-way bet it was last year," Lennox wrote in a note to clients.
The dollar also received a boost from technical buying after the previous session's losses, but price action was confined to tight ranges ahead of a speech on the U.S. economy by Federal Reserve Chairman Ben Bernanke on Thursday.
Sterling, meanwhile, hit a record low against the euro and a nine-month trough against the dollar as renewed fears about the British retail sector stoked expectations of a UK interest rate cut.
The euro was up 0.4 percent against the British pound at 74.83 pence, having reached a record post-1999 launch peak of 75.03 pence.
Sterling fell 0.7 percent against the dollar to $1.9568 , trading as low as $1.9555, the lowest level since late March.
The ECB will hold a monetary policy meeting on Thursday and investors expect the bank to hold interest rates steady at 4.0 percent. Still, markets will be closely watching comments from ECB President Jean-Claude Trichet, given a spate of weak economic euro zone numbers.