The dollar fell to a one-month low on Thursday as rising mortgage delinquencies and ongoing credit concerns stoked fear of slower U.S. economic growth ahead of a keenly awaited employment report.
The euro got a boost after the European Central Bank left interest rates unchanged at 4 percent but said inflation remains a concern, suggesting hikes may resume in the future.
By midafternoon, the market had renewed its focus on a dollar looking increasingly vulnerable against the backdrop of the credit squeeze and a deepening housing slump.
The market may be finally beginning to focus on the idea that whatever problems that are here on the markets side and the economy and housing side are really predominately a U.S. problem, said Tom Fitzpatrick, global head of currency strategy at Citigroup in New York.
The dollar index, which measures the greenback against a basket of currencies, hit a one-month low at 80.404. The dollar edged up 0.1 percent to 115.30 yen.
The euro gained 0.4 percent at $1.3700, having pushed through a key resistance area around $1.3685 after ECB President Jean-Claude Trichet said he continues to monitor inflation closely.
Trichet said turmoil in credit markets had increased uncertainty but also said policy remains accommodative.
While he did not say the ECB was exercising strong vigilance -- code for a rate hike -- he did say he would use the phrase again if and when the time comes.
Trichet confirmed that a rate hike to 4.25 percent is still on the books this year, said David Powell, senior currency strategist at IDEAglobal in New York. People had thought this could be the end of the ECB rate cycle, but it seems Trichet is saying this is a pause.
The Bank of England also held rates steady on Thursday, as did the Bank of Canada and the Reserve Bank of Australia earlier in the week.
U.S. JOB REPORT, FED IN FOCUS
Those moves left markets to focus on the Federal Reserve, which investors expect to deliver at least a 25 basis point cut to its 5.25 percent federal funds rate on September 18.
This week's action by four major central banks raises the chances that the Fed will cut rates, said Michael Woolfolk, senior currency strategist at The Bank of New York Mellon.
I still think the current market circumstances will trump the Fed's inflation bias and concerns.
Indeed, signs of a credit turmoil remained on Thursday. A $54.1 billion retrenchment in the commercial paper market suggested firms are still having trouble raising short-term capital.
The Fed flooded the market with $31.25 billion on Thursday in three separate operations designed to loosen up liquidity, while the ECB injected 42.25 billion euros.
Meanwhile, an industry report showed U.S. home loan delinquencies rose in the second quarter while the number of loans entering foreclosure hit a record high.
A separate report showing employment in the U.S. services sector hit its lowest level since December 2002 was also a menacing sign for the dollar.
Alan Ruskin, international strategist at RBS Greenwich Capital, said the data suggests Friday's employment report may show fewer than 100,000 new jobs added last month.
There's little positive to take away for the dollar, although positioning will remain restrained before the jobs number, he said.
(Additional reporting by Kevin Plumberg)