The dollar rose on Thursday, boosted by better-then-expected jobless claims data, but support remained fragile as oil surged to record highs before retreating in later trading.
Firm euro zone economic data this week and persistent inflation boosted the euro to $1.5814 overnight, a one-month high, but it retreated when investors began taking profits.
A report showing Americans filed fewer than expected applications for first-time jobless benefitsalso provided a dollar boost, as it showed the U.S. labor market is "still shy of typical full-blown recession levels," said Alan Ruskin, international strategist at RBS Greenwich Capital in Greenwich, Connecticut.
But traders said the market remained focused on oil, which jumped above the $135 a barrel mark
"The dollar is up on profit-taking more than anything else, because the mood has turned against the dollar," said Matthew Strauss, currency strategist at RBC Capital Markets in Toronto, adding the swing was driven by oil and stronger European data.
The euro was last trading down about 0.5 percent but remained near the top of a well-worn $1.54-$1.58 range that has persisted most of the month.
Sterling rose 0.4 percent to $1.9790 on stronger-than-expected UK retail sales.
The yen also wilted, as traders expected surging oil prices to hurt Japan's economy, a net importer of energy. The dollar rose more than 1 percent versus the yen, while the euro rose 0.5 percent to 163.31 yen.
"With oil at $135, every economy and every nation's inflation outlook is at risk," said David Gilmore, partner at Foreign Exchange Analytics in Essex, Connecticut.
Analysts said the dollar remains doubly vulnerable.
On Wednesday, the Federal Reserve downgraded its 2008 U.S. economic growth forecast and raised its inflation outlook.
"If growth continues to deteriorate, we could run into a stagflation situation where nobody wants to hold dollars," said Robert Kowit, who helps manage a $3 billion bond fund for Federated Investors in Pittsburgh. "Then you could face a big downside for the dollar, which would force people to look at non-dollar assets in other developed markets to offset their losses."
But fears of stagflation "can also turn the focus of the Fed to deprioritize growth and focus on inflation, increasing the prospects of higher rates and a dollar supportive yield curve," said Chris Turner, head of FX strategy at ING in London.
The Fed has cut target interest rates from 5.25 percent to 2 percent since September, but markets now expect them to hold steady and possibly hike borrowing costs by year end.
Persistently high inflation and a rise in German business confidence also has increased expectations that the European Central Bank's next interest rate move may be an increase from the current 4 percent.
The biggest mover among the majors was the New Zealand dollar, which jumped more than 1 percent to a session high of US$0.7895 thanks to a bigger than expected $8.2 billion cut in personal taxes in the 2008-09 budget.