The dollar fell versus the euro on Wednesday after the previous day's quarter-point rate cut from the Federal Reserve disappointed investors hoping for more aggressive action to help the economy and credit markets.
The Fed trimmed both the benchmark fed funds rate and the discount rate for lending to banks by a quarter point, to 4.25 and 4.75 percent respectively. Some had expected a bigger discount rate slash to help strained money markets at year-end.
However, the U.S. currency managed to make some progress versus the yen, while high yielders rallied after a Fed source said the central bank was actively considering all of the tools it has available to address liquidity measures.
Some media reports said action from the Fed on liquidity could come within days, even as soon as Wednesday.
The year-end period traditionally sees thinner liquidity, but the situation is exacerbated this year by troubles in the U.S. subprime mortgage market and the subsequent credit crunch, which have left banks unwilling to lend to each other.
Some participants were expecting a bigger cut than 25 bps and some were also expecting a more aggressive decision on the discount rate. So ... that's somewhat disappointing and equity markets were quite down in the U.S. session, said Carole Laulhere, currency strategist at Societe Generale in Paris.
Clearly the major risk is that the Fed is forced to cut rates once again ... The other opportunity will be that the Fed may cut the discount rate more aggressively, and another possibility will be for the Fed to inject more liquidity by the end of the year, she said.
The euro rose 0.2 percent to $1.468, while sterling added 0.3 percent to $2.0398.
However, the dollar recovered some of its earlier losses after Chinese central bank governor Zhou Xiaochuan said China supported a strong dollar.
HIGH YIELDERS RALLY
The high-yielding Australian dollar rallied around 1 percent versus the U.S. currency, while the New Zealand dollar was up 1.5 percent by 0312 EST.
The yen, which is a popular funding currency for carry trades and tends to move inversely with high-yielders, fell 0.6 percent to 111.28 per dollar.
The euro was up 0.8 percent at 163.38 yen.
Trade was fairly thin as many market players keep positions limited before closing their books for 2007 later this month, while keeping an eye on whether conditions in money markets deteriorate further.
Wednesday's calendar features U.S. trade data for October at 0830 EST, and Norway's latest rate decision at 0800 EST.
At a time when British and Canadian central banks have joined the Fed in cutting rates, Norges Bank is expected to hike by 25 basis points to 5.25 percent as domestic growth has held up well despite troubles in the global financial markets.
Ahead of the decision, the Norwegian crown was up around a third of a percent at 5.4429 per dollar.
In the United States markets have fully priced in one more rate cut in January and another by the end of April.
(Editing by Mike Peacock)