The dollar struggled near a seven-month low against a basket of major currencies on Thursday after the Federal Reserve wrong-footed many investors who had positioned for a scaling back in its massive stimulus program.
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The dollar index was down 0.1 percent, adding to the previous session's 1.2 percent drop, its biggest one-day slide in more than 2 months, after the Fed maintained its $85 billion monthly asset-buying programme, confounding expectations of a reduction by roughly $10 billion.
It has fallen to levels seen well before Fed Chief Ben Bernanke first floated the idea of tapering the stimulus in May.
The dollar index last stood at 80.127, after having fallen to 80.060 on Wednesday, its lowest level since February. It fell as rate-sensitive U.S. Treasury yields, with which the index has a strong correlation, slid to 0.32 percent from a recent two-year high of 0.52 percent.
The dollar's losses saw the euro hit a 7-1/2 month high. The euro was last trading slightly firmer at $1.3538, having hit a high of $1.3546.
Sterling was also trading near 8-month high of $1.6164 struck on Wednesday when it posted its largest daily percentage gain in three years. It was last trading at $1.6135.
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"U.S. yields are lower and it makes sense to move out of dollars into the euro and sterling," said Jeremy Stretch, head of currency strategy at CIBC World Markets.
"By the time, we have the European Central Bank meeting early next month, we could have the euro at $1.37 which will pose a headache to (President Mario) Draghi."
A stronger currency would hurt exports and is the last thing the ECB would want, given it has pledged to keep monetary policy accommodative for longer to support a nascent economic recovery.
HIGHER YIELDING CURRENCIES FARE WELL
Citing tightening financial conditions, Fed Chairman Ben Bernanke refused to commit to begin reducing the bond purchases this year. As well, the central bank cut its growth forecasts for 2013 and 2014, citing strains in the economy from tight fiscal policy and higher mortgage rates.
The surprise decision saw U.S. Treasury yields tumble while riskier assets like stocks, stage a rally.
U.S. benchmark 10-year yields dropped to a one-month low of 2.673 percent on Wednesday, well off highs around 3.01 percent set earlier in the month. The 10-year Treasury yield last stood at about 2.697 percent.
Higher-yielding currencies fared well. The New Zealand dollar climbed 0.6 percent on the day to $0.8411. It set a four-month high of $0.8415, getting an added lift after data showed New Zealand's economy grew at a better-than-expected pace in the second quarter.
The rally in riskier assets weighed on the safe haven yen, and helped the dollar regain some ground. The dollar rose 0.65 percent to about 98.66 yen, pulling away from Wednesday's three-week low of 97.76 yen.
Mitul Kotecha, head of global foreign exchange strategy for Credit Agricole in Hong Kong, said the dollar's moves versus the yen were being influenced by two conflicting factors, the drop in U.S. bond yields on the one hand and a bounce in risk appetite on the other.
"In a way dollar/yen is conflicted, it's in a battle between these two factors," Kotecha said. "The Fed is clearly trying to cap U.S. yields, and I think from that perspective dollar/yen may struggle to push higher in the short term," he added.