The dollar fell to a two-week low on the euro and an 11-year trough versus sterling on Monday as the market decided a Group of Seven warning against "excess volatility" in exchange rates did not herald action to support the greenback.
In a see-saw reaction to a weekend statement from G7 finance ministers, the dollar jumped nearly one percent against the euro at the start of Asian trade but quickly reversed its gains as the market grew skeptical the G7 stance signaled intention to intervene.
The dollar has come under broad-based pressure, particularly against the euro, on the view that the U.S. current account deficit is unsustainable and the U.S. administration is happy to see it fall to correct that imbalance and boost economic growth ahead of November's presidential elections.
"The G7 statement was not significantly strong enough to hint they were prepared to consider intervention at this time," said Kaman Sharma, currency strategist at Dresdner Kleinwort Wasserstein in London.
"Now that the G7 risk has disappeared the market will look to factors such as U.S. economic data, market positioning and (Federal Reserve Chairman Alan) Greenspan's testimony," he said.
"And in the medium-term the U.S. current account deficit will keep the dollar under pressure."
By late morning in Europe, the euro was at $1.2730, a quarter of a percent up from pre-G7 levels on Friday. Earlier it hit a two-week peak around $1.2760, some 1-1/2 cents below last month's record high, extending a 1.3 percent gain on Friday after disappointing U.S. jobs data reinforced expectations for continued low U.S. interest rates.
The dollar was holding at 105.60 yen, just above a three-year low set last week. It also hit an 11-year low of $1.8628 per British pound as European business opened, but regained some ground after disappointing UK manufacturing data hurt sterling.
Meanwhile, the euro briefly touched a two-week high of 134.93 yen while the dollar fell to a fresh 6-1/2 year low against the New Zealand dollar and shed one percent against the Australian dollar.
Later in the week, markets will be focusing on Greenspan's semi-annual testimony on monetary policy before the House Financial Services Committee, which is scheduled for Wednesday.
The G7, on top of its standard communique phrases about monitoring foreign exchange markets closely, said: "Excess volatility and disorderly movements in exchange rates are undesirable for economic growth."
The reference to volatility was seen as a change of emphasis to counter the impact of the G7's call in Dubai last September for "more flexibility" in exchange rates, which sparked a 10 percent drop in the dollar's value against the euro, ringing alarm bells among euro zone officials.
Analysts said the shift in wording was likely a compromise between the U.S., which backs market flexibility that allows for growth-supporting dollar falls, and Europe which wants to prevent excessive market movements from hurting its own recovery.
"It was a compromise between U.S. and Europe. There appears to be a stalemate and in this condition the natural trends in euro/dollar will take over," said Sharma.
The G7 also narrowed its Dubai call for currency flexibility to countries "that lack such flexibility".
Traders assumed the shift was aimed at China and other Asian countries that peg their currencies to the U.S. dollar, although speculation simmered over whether Japan, which has engaged in massive dollar-buying intervention in the past year, was also under fire.
Japanese Finance Minister Sadakazu Tanigaki said on Saturday the statement urging more currency flexibility was not aimed at Japan.
Zembei Mizoguchi, Japan's vice finance minister for international affairs, said on Monday the group's statement showed no discrepancy with Japan's policies and vice finance minister Masakazu Hayashi said the country's intervention stance was unchanged and exchange rates should reflect economic fundamentals.
Japan sold a record 20 trillion yen ($188.8 billion) last year and another seven trillion yen last month to curb the yen's export-hurting rise. Traders expect it to continue intervening should the dollar threaten to fall below 105 yen.
"Some people are saying Japan was the biggest winner from this statement," said Shahab Jalinoos, senior currency strategist at ABN Amro in London. "Japan seems to have got implicit ok from the other G7 players to carry on intervening."