The dollar trimmed gains against the euro and yen Tuesday after the Federal Reserve kept benchmark interest rates unchanged at 2 percent as expected and said risks remain to U.S. economic growth.
The drop in oil helped quell fears high energy prices will continue to weigh on the U.S. economy at a time consumer prices are showing an unexpectedly fast rise.
"Despite the Fed and the ECB meetings this week, oil is really becoming the short-term focus in the foreign exchange markets," said Omer Esiner, a currency analyst at Ruesch International in Washington, D.C. "It is really helping push the dollar up."
The euro edged higher against the dollar to $1.5485 from $1.5460 before the rate decision. Against the yen, the dollar slipped to 108.20 yen from 108.30 previously.
It was the first time the euro zone common currency had traded below $1.55 since June.
Oil fell to a three-month trough of $118 per barrel while metals and other commodity prices dropped further as concern over slowing global demand sparked profit-taking.
The dollar index, which measures the U.S. currency's performance against a basket of six currencies, climbed as high as 73.943, its highest since mid-June.
Esiner said a further drop in crude prices and a hawkish statement by the Fed at Tuesday's meeting may help push the euro to $1.5430.
A close below that may pave the way for a further decline to $1.5400, he said.
The Fed maintained benchmark interest rates at 2.0 percent and highlight concerns on inflation and widening losses in the U.S. financial system.
The European Central Bank is expected to leave rates unchanged at 4.25 percent at its meeting on Thursday.
U.S. government data on Monday showed an unexpected surge in consumer prices in June. (Watch the accompanying video to hear how an economist thinks the dollar will perform against commodity currencies...)
Another report on Tuesday showed the U.S. service sector shrank slightly in July but by less than economists had expected.
"The ISM non-manufacturing index was a little better than expected," says Vassili Serebriakov, currency strategist at Wells Fargo. "This index indicates that the economy is marginally in contraction territory. But the reaction of the FX market was fairly muted ahead of the Fed decision."
Soft economic data from the euro zone helped keep selling pressure on the euro. A report showed June retail sales in the euro zone fell more than expected.
The upside in the single currency remains limited amid deteriorating growth conditions in the euro zone, analysts at UBS AG said in a note.
"With the economic slowdown progressing more rapidly than the (ECB) Governing Council expected, a shift to a downside is possible and this will hurt EUR/USD further," the bank said.
Central Bank Meetings
The Australian dollar was among the weakest performers on Tuesday. The Reserve Bank of Australia kept interest rates at 7.25 percent but sent a strong signal it will ease soon as tighter credit conditions and slowing demand should cool inflationary pressures.
"The RBA has clearly signaled its intent to cut rates and the market understands it to mean a move at the next meeting in September," currency strategists at Brown Brothers Harriman in New York said in a note.
The Australian dollar was down sharply against the greenback.
Investors sold the Aussie against a host of currencies, particularly the low-yielding yen, which also benefited from buying against the euro and sterling.
The RBA's rate decision began a week of major central bank rate decisions. The U.S. Fed announces its decision around 2:15 pm on Tuesday. The ECB and Bank of England will both announce their rate decisions on Thursday.