The euro slipped against the dollar on Thursday and stock markets rose ahead of a European Central Bank meeting that is likely to flag a halt to its monetary tightening cycle.
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With the euro zone economy clearly slowing further, markets have already firmly priced in an end to the rate hike cycle which started just two months ago, and the single currency could in fact get a lift if ECB boss Jean-Claude Trichet quashes speculation of rate cuts to support economies battered by the debt crisis.
Traders will also be looking at what the central bank says about the bank's buying of southern European and Irish bonds given that the ECB is internally divided over the programme
"Markets are a bit cautious going into the ECB rate meeting," said UBS currency analyst Chris Walker. "We could see a bounce in the euro as pricing in for rate cuts in October is a bit far fetched.
Walker added however that any bounce would be short-lived as the continent's financial system and southern European states remain under serious threat from the debt crisis.
The euro was down 0.2 percent at $1.4064 .
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The British pound also fell ahead of a Bank of England meeting, tumbling to an eight-week low of $1.5917 on speculation the BOE could announce more stimulus to shore up the economy.
More quantitative easing (QE) in the form of asset purchases would be negative for the British currency as it would flood the market with pounds.
While most expect the BOE will merely hold rates at a record low 0.5 percent and avoid adding to its 200 billion pound bond buying programme, some said the recent run of sluggish economic data has prompted traders to position for the off-chance of more stimulus.
"If there's no QE I see a 100 point rally (in the sterling-dollar exchange rate) before it comes off again," a currency trader in London said.
The economic growth worries gripping global markets were further highlighted by an OECD report that warned central banks to brace for weaker growth.
The Organisation for Economic Cooperation and Development said on Thursday that developed countries face a sharp year-end slowdown led by a contraction in Germany.
EQUITIES, DOLLAR UP, PRESSURE REMAINS
Equity markets were also on edge. World stocks as measured by MSCI rose a marginal 0.3 percent, adding to the previous session's 2.7 percent rally that was fuelled by a German court's ruling supporting the government's bailouts for other euro zone states.
While the index has recovered somewhat from its August correction -- the worst monthly loss since 2008, it remains 16 percent below the 2011 highs hit in May.
The FTSEurofirst 300 index of top European shares had also gained almost 1 percent by 0900 GMT, led by banking shares which are benefiting from hopes of a dovish ECB.
The dollar rose 0.2 percent to 77.37 yen and also firmed to a 3-1/2 month high against the Swiss franc.
The latter has continued to weaken against the dollar and euro after the Swiss central bank said this week it was determined to cap the currency's strength.
However the dollar is likely to stay under pressure, especially as some traders expect that a 1730 GMT speech by Federal Reserve chairman Ben Bernanke could provide hints on the likelihood of more stimulus.
Initial excitement over U.S. President Barack Obama's plan to propose new job measures, due at 2300 GMT, has also begun to wear off amid doubts over how much Washington can spend after the acrimonious debt ceiling saga just over a month ago.
Investors are now eyeing a Group of Seven meeting starting on Friday for some guidance about what authorities plan next to avoid a return to recession.
Some analysts believe the economic situation is such that coordinated monetary policy easing may be needed and some banks such as Barclays predict that the U.S. Federal Reserve would indulge in a new form of quantitative easing in which it sells short duration bonds and buys longer ones.
German government bonds rose ahead of the ECB announcement with December Bund futures up 29 ticks and benchmark 10-year yields down one basis point at 1.866 percent.
Traders saw scope for a fall in prices after the meeting.
"The risk is that the market is disappointed temporarily if they don't turn full circle in one meeting, but it's unlikely to be a dramatic sell-off," one bond trader said.