The dollar extended its recovery on Monday, climbing to its highest in a month against the euro as the market expected the U.S. Federal Reserve to trim rates this week and awaited its assessment of the economy.
The Fed starts its two-day meeting on Tuesday and is expected to cut rates by up to 50 basis points on Wednesday.
A rate cut is seen as negative for the dollar in a market where higher-yielding currencies perform the best but the recent rebound on Wall Street has shifted investor focus onto equities, which favour a growth-boosting easing. Analysts said the Fed's rationale for its decision will be as important as the actual move.
"They will want to have something that is good for equities and good for bonds," said Adrian Schmidt, market strategist at Royal Bank of Scotland.
"That's not very easy but they've managed it most of the year by saying they would keep rates low and expected growth to be good. They're still going to say that -- the question is whether they have reached the limit at which you can do this."
By 0949 GMT the dollar had risen two thirds of a percent to $1.1526 from $1.1606 in late New York on Friday, having retested a record low around $1.1930 only a week ago.
The euro dipped to 136.07 yen , its lowest since mid-May, with Tokyo dealers citing sales from some hedge funds.
Falls in euro/yen pushed down the dollar against the yen, with the pair at 118.05 yen compared with Friday's late New York level of 118.51.
SIZE DOESN'T MATTER?
The market is divided over whether the Fed will reduce the bellwether federal funds rate, already at a 42-year low of 1.25 percent, by 25 basis points or a more aggressive 50.
A larger cut would put the spotlight on the growing interest rate gap between the United States and the euro zone and could further buoy flows into European bond markets, underpinning the euro. But an aggressive rate cut is also likely to boost share prices and thus the dollar's appeal.
"A 25 basis points cut will see a further dollar rally, but the reaction of the stock market is very important. It is still premature to anticipate that the worst is over in the U.S. so the dollar's recovery can be fragile," said Shahab Jalinoos, currency strategist at UBS.
Fed Governor Donald Kohn said on Friday central bank statements play a "vital" role in shaping market views on the likely path of monetary policy and could be "especially important" when interest rates are low and an economy needs a boost.
The comments raised speculation the Fed will use its statement to clarify that it is intent on keeping rates low for a long period of time to fend off the threat of deflation.
"If they do 50 it's more negative for the dollar. But if they signal that they remain fairly upbeat or confident that the U.S. recovery will continue then that will significantly negate the downside for the dollar," said Ryan Shea, international economist at Bank One in London.
In Europe, European Central Bank council member Ernst Welteke discouraged talk of further euro zone rate cuts or intervention to curb the strong euro.
Welteke and German Finance Minister Hans Eichel are holding a regular Franco-German economic meeting with French Finance Minister Francis Mer and Bank of France governor Jean-Claude Trichet. They hold a news conference at 1230 GMT.
The Fed starts its two-day meeting on Tuesday and is expected to cut rates by up to 50 basis points on Wednesday.
A rate cut is seen as negative for the dollar in a market where higher-yielding currencies perform the best but the recent rebound on Wall Street has shifted investor focus onto equities, which favour a growth-boosting easing. Analysts said the Fed's rationale for its decision will be as important as the actual move.
"They will want to have something that is good for equities and good for bonds," said Adrian Schmidt, market strategist at Royal Bank of Scotland.
"That's not very easy but they've managed it most of the year by saying they would keep rates low and expected growth to be good. They're still going to say that -- the question is whether they have reached the limit at which you can do this."
By 0949 GMT the dollar had risen two thirds of a percent to $1.1526 from $1.1606 in late New York on Friday, having retested a record low around $1.1930 only a week ago.
The euro dipped to 136.07 yen , its lowest since mid-May, with Tokyo dealers citing sales from some hedge funds.
Falls in euro/yen pushed down the dollar against the yen, with the pair at 118.05 yen compared with Friday's late New York level of 118.51.
SIZE DOESN'T MATTER?
The market is divided over whether the Fed will reduce the bellwether federal funds rate, already at a 42-year low of 1.25 percent, by 25 basis points or a more aggressive 50.
A larger cut would put the spotlight on the growing interest rate gap between the United States and the euro zone and could further buoy flows into European bond markets, underpinning the euro. But an aggressive rate cut is also likely to boost share prices and thus the dollar's appeal.
"A 25 basis points cut will see a further dollar rally, but the reaction of the stock market is very important. It is still premature to anticipate that the worst is over in the U.S. so the dollar's recovery can be fragile," said Shahab Jalinoos, currency strategist at UBS.
Fed Governor Donald Kohn said on Friday central bank statements play a "vital" role in shaping market views on the likely path of monetary policy and could be "especially important" when interest rates are low and an economy needs a boost.
The comments raised speculation the Fed will use its statement to clarify that it is intent on keeping rates low for a long period of time to fend off the threat of deflation.
"If they do 50 it's more negative for the dollar. But if they signal that they remain fairly upbeat or confident that the U.S. recovery will continue then that will significantly negate the downside for the dollar," said Ryan Shea, international economist at Bank One in London.
In Europe, European Central Bank council member Ernst Welteke discouraged talk of further euro zone rate cuts or intervention to curb the strong euro.
Welteke and German Finance Minister Hans Eichel are holding a regular Franco-German economic meeting with French Finance Minister Francis Mer and Bank of France governor Jean-Claude Trichet. They hold a news conference at 1230 GMT.
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