The dollar jumped to a two-month high against the euro on Tuesday as the market swung its attention back to the attraction of rising interest rates in the United States.
The dollar also broke further from a five-year low versus the yen as some dealers focused on the Federal Reserve's tightening campaign, which has not stemmed the dollar's broad decline despite rates rising on five occasions since June.
"At some point the rising yield differential between the dollar and currencies like the euro has got to start helping the dollar," said Toshiaki Kimura, a forex manager at Mitsubishi Trust and Banking.
"Many think that turning point is getting close."
Dealers said that the dollar, which has lost 31 percent against the euro and 22 percent versus the yen in the past three years, also gained support from speculation that the United States may take steps to reign in its ballooning budget deficit.
Much of the dollar's decline had been driven by concerns that the United States would struggle to attract enough capital from overseas to finance its growing external deficit.
A large budget deficit exacerbates the current account problem because U.S. savings are so low that much of the gap has to be funded with foreign capital.
Some market players are looking for President Bush to announce concrete steps to rein in spending at his inauguration on Thursday or State of the Union speech around two weeks later.
The market will be closely watching U.S. capital flow figures due at 9 a.m. EST, which could put worries about the U.S. current account deficit back in the spotlight, particularly in light of a record U.S. trade deficit of $60.3 billion in November.
The euro traded at around $1.3030 as of 10:20 p.m. EST Monday, after falling to around 1.3010, its lowest level since Nov. 23.
The single European currency was down 0.3 percent on the day and around 4.7 percent below a record high of $1.3670 hit in December.
The dollar fetched about 102.45 yen, up 0.4 percent from its level in late London trade, where the U.S. currency touched 101.67 yen its lowest level since January 2000.