The dollar rose to a two-month high against the yen and held near three-month peaks versus the euro on Tuesday as the market cheered U.S. efforts to narrow its yawning fiscal deficit.
President Bush submitted a proposal to Congress on Monday that forecast a narrowing in the budget deficit to 1.7 percent of gross domestic product by fiscal 2008 from 3.5 percent in the current year.
Twin U.S. budget and current account deficits have been a key factor in the dollar's three-year downturn.
Adam Cole, senior currency strategist at RBC Capital Markets, said easing oil prices and rising hopes for peace in the Middle East were also supporting the dollar.
"The budget may have helped, but rising risk appetite and falling oil prices have also been a factor in the dollar's bounce," he said.
Israeli and Palestinian leaders are expected to announce a cease-fire to halt more than four years of bloodshed at a landmark summit later on Tuesday.
The dollar was up 0.5 percent at 105.34 yen and steady against the euro at $1.2770 in early European trade.
The euro has now lost 6 percent against the dollar since the start of the year after hitting record highs above $1.36 in the final days on 2004.
RANGE BREAKOUT
Analysts said the euro's recent break below key technical levels against the dollar had forced investors, who had bet on a weakening U.S. currency, to cover their positions.
The euro suffered its steepest one-day decline against the dollar on Monday since early January, slipping through key chart levels to hit a three-month low around $1.2730.
Some traders, however, were not convinced the twin U.S. budget and current account deficits would become less of a problem for the dollar.
"The figures that Bush submitted are just proposals and we don't know if the budget will actually be cut (by that degree)," said Jun Kitazawa, assistant vice president of the forex section at Brown Brothers Harriman in Tokyo.
"It's dangerous to chase the dollar up too high," he said.
Fed Board Governor Susan Bies also sounded a note of caution, saying any country that had as big a trade gap as the United States would likely see its currency fall.
Bies also said inflation had ticked up recently, though she reiterated the central bank was expected to raise rates at a "measured" pace.
With the market's attention focused on the U.S. deficits, traders were eager to hear U.S. Treasury Secretary John Snow's testimony on the U.S. budget at 10 a.m. EST. He will also testify before the Senate Finance Committee at 2 p.m. EST.
Federal Reserve Chairman Alan Greenspan said late last week that market forces and a more austere U.S. fiscal policy should stabilize and may cut the current account deficit.
Analysts said the tone of Greenspan's comments was in stark contrast to comments in November, when he said the United States should cut its budget deficit to protect its economy from an inevitable dwindling of overseas appetite for dollar assets.