Take this strong dollar: Euro soars

The euro jumped to a two-month high against the dollar on Thursday in a move that analysts said could be attributed to one key factor: a scaling back of U.S. rate hike expectations.

The single currency rose more than 1 percent on the day to about $1.1250 – its highest level since late February. It marks a change in course after falling for several months against a broadly robust dollar.

Philippe Huguen | AFP | Getty Images

"The euro's strength today is not about what's boosting it but about what's hurting the dollar," Geoffrey Yu, a senior currency strategist at UBS, told CNBC.

"Federal Reserve rate hike expectations have taken a knock and the debate has switched from how many times will the Fed hike rates this year to if the Fed will hike rates this year."

Talk that the Fed could hike rates later rather than sooner was fueled on Wednesday by news that the U.S. economy grew at an annual rate of just 0.2 percent in the first three months of the year. The Fed also downgraded its view of the U.S. labor market and economy following a policy meeting.

Read MoreNot yet: Fed holds rate at zero, no hint for hike

Indeed, reflecting a scaling back of U.S. rate hike expectations, the dollar was broadly weak against major currencies on Thursday.

The dollar index, which measures the greenback's value against a basket of major currencies, fell to a two-month low at about 94.4.

"The huge move in euro/dollar which is up nearly four big figures this week has caught many market participants by surprise," said Boris Schlossberg, managing director of FX Strategy at BK Asset Strategy, in a note."

"The move has been fueled by a massive realignment in the dollar trade as consensus view about the Fed is starting to change quickly," he added.

Monetary policy expectations have been the key driver for major currencies this year, with a 1-trillion-euro ($1.12-trillion) stimulus program from the European Central Bank helping push the euro down, while expectations for the first U.S. rate increase since 2006 pushed the dollar higher.

Currency analysts said signs of improvement in the euro zone economy and a rise in government bond yields in Germany - Europe's biggest bond market - was also lending some support to the single currency.

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Data on Thursday showed that German unemployment fell in April to its lowest level in 24 years as a rebound in Europe's biggest economy gains speed. Meanwhile, separate figures revealed that the euro zone had emerged from fourth months of deflation in April.

How the US dollar might improve

End short-euro trade?

Analysts said that while this week's rally in the euro suggested currency markets were unwinding short euro trades -- a bet that the single currency is likely to weaken -- this was unlikely to last too long.

"This is largely because of the slowdown we see in the U.S. and shifting expectations of the timing of rates increase there," Goldman Sachs Chief Global Equities Strategist, Peter Oppenheimer, told CNBC, referring to the unwinding of short euro trades.

"But ultimately I think it's likely that rates are going to rise in the U.S. well before they do in Europe and those interest-rate differentials will move the currency still quite a long way," he added.

Goldman Sachs maintained a view that the euro would weaken to 95 cents against the dollar over the next 12 months, Oppenheimer said.

Swiss bank UBS also held its forecast for the euro, which it expects to end the year at about $1.05.

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