The dollar is mostly higher in hectic trading. Currency investors pocketed profits from the euro's big run up and reversed an initial dollar sell-off after a tame reading of November inflation.
Traders said institutional investors were behind a euro sell-off that drove the currency to a session low.
"It seems some real money is selling the currencies, buying dollars. It's nothing other than people booking profits. People are taking money off the table that's been there for some time," said John McCarthy, vice president of foreign exchange at ING Capital Markets in New York.
Earlier, the dollar fell following a tame reading of U.S. consumer inflation, which raised expectations for an early-2007 benchmark interest rate cut. Lower interest rates in the United States would erode the dollar's yield advantage and make the currency less attractive to investors.
The government said the core consumer prices, which strip out food and energy costs, were unchanged last month, compared with October's 0.1% rise. Economists had expected core consumer prices to increase 0.2% and the report overshadowed data on industrial output and capital flows.
"The market's looking at CPI as the key of the three reports," said Dustin Reid, senior currency strategist at ABN AMRO in Chicago.
A fairly robust increase in net capital inflows into the United States in October was not sufficient to help investors shake off concerns about a Fed rate cut.
"It's an interest rate reaction at the moment, so TICS is a nice number but it's not enough to counteract the interest rate play that's in place at the moment," said Brian Dolan, director of research at Forex.com in Bedminster, New Jersey.
"Fed funds futures had taken off the prospect of easing in the first quarter and now that's starting to creep back in," he said.
Opinion in the market is divided as to when the Fed may have to first cut U.S. rates to support growth. The central bank said earlier this week that it expected inflation to continue to moderate over the coming months but did not suggest a rate cut was on the cards just yet.
The euro had earlier erased all its losses against the dollar but a bout of technical selling against the yen dragged the euro down.
The market is once again pricing two rate cuts from the Fed by mid-2007 and benchmark Treasury yields staged their largest one-day decline in over six months, offering a clear indication that investors expect lower interest rates in the longer-term.
Against the yen, sterling hit fresh eight-year lows after news of that Japan Tobacco had agreed to buy British cigarette maker Gallaher Group for $14.7 billion -- the largest foreign acquisition by a Japanese company.
The yen was also under pressure against other crosses after an upbeat read of Japanese manufacturing sector sentiment did not reignite expectations for the Bank of Japan to raise rates to 0.5% when it meets next year.