The dollar rose more than half a percent against the euro on Friday as traders looked ahead to next week's U.S. central bank meeting and decided the greenback's slide over the past month had gone far enough.
Markets have already priced in a quarter-point rise in U.S. interest rates next Tuesday and will focus attention on the Federal Reserve statement for clues on how fast rates will go up in the coming months.
After a wave of selling since mid-February, the dollar has steadied this week, helped by figures showing foreign buying of U.S. assets has been more than enough to cover the United States' huge trade deficit.
"There is a sense that the dollar's sell-off has moved very far very quickly and a lot of dollar-positive cyclical numbers have been ignored," said Daragh Maher, currency strategist at Calyon.
The dollar -- which fell to two-month lows against the euro and six-week lows against the yen last week -- was up half a percent at $1.3305 per euro (EUR=) and up a third of a percent at 104.84 yen (JPY=) at 7:38 a.m. EST.
U.S. import prices for February are due at 8:30 a.m. EST and give clues on how much of a pass-through effect dollar weakness is having on the trade deficit.
So far the dollar's three-year decline has had only a modest effect on the price of imported finished goods and data last week showed the U.S. trade gap widened to a near-record $58.3 billion in January.
OPPOSING FORCES
The dollar has yo-yoed this year between optimism about the U.S. economy and the upward path of U.S. interest rates and pessimism over the United States' ability to finance its record current account deficit.
Such pessimism eased this week after data showed net capital inflows into the United States surged to $91.5 billion in January, the second biggest inflow on record and more than enough to finance the nation's current account deficit.
Rising U.S. rates are likely to bring back some of the funds that have poured into assets that have boomed this year, including stocks in other countries and commodities.
"The market is expecting 25 basis points and will get it on Tuesday, but there is a significant risk there will be a change in the statement to be more hawkish," said Geoff Kendrick, currency strategist at Westpac.
The Fed has raised rates by a quarter percentage point at six straight meetings, taking the key U.S. rate to 2.5 percent.
Some in the market expect U.S. rates to rise as high as 4 percent by the year-end, though the pace of increases might be tempered by Fed chief Alan Greenspan's desire to sail a steady ship before his term ends next January.
Greenspan is due to speak at noon EST, though he is not expected to comment on the economy or interest rates so near to the policy meeting.