The U.S. dollar rose from the day's lows on a broad bout of short covering on Tuesday while Asian stocks pulled back slightly from a one-month high as some investors took profits from their recent rally.

Foollowing a late dip in Asian equities, European markets were set to open flat to marginally weaker before euro zone services PMI and retail sales data.

A pick up in demand for risky assets from last week softened a bit on some speculation about a possible rate rise in China this weekend, as well as a Moody's report saying the scale of problem loans at local governments in China may be much bigger than previously thought.

The Australian dollar languished near the day's lows after the central bank bank held interest rates at 4.75 percent, as widely expected, and said the economy was unlikely to grow as strongly in 2011 as it first thought, supporting market bets that rates could be on hold for a while longer.

The RBA's dovish comments led to a short squeeze in the U.S. dollar which scored chunky gains against the high-yielding Australian dollar and the euro in the run up to the Australian rate decision which was along expected lines.

It's a classic short squeeze in the dollar, but I don't think the recent 'risk-on' trend has changed because of this sharp move, said Tsutomu Soma, a senior manager at Okasan Securities.

Both the Aussie and euro were overbought, so many players simply wanted to lock in profits made on those rallies, Soma said.

After the decision, the Aussie held near the day's lows of 1.0673, but still retained a large chunk of its 3 percent gains earned since last week.

The euro turned lower on the day at $1.4472, though it still held within striking distance of a one-month high against the U.S. dollar before a much expected interest rate increase on Thursday where a hawkish European Central Bank might attract more buyers to the beleaguered currency.

With Greek default fears also being relegated to the back burner for now, BNP Paribas strategists expect more real money investors and leveraged accounts to start buying euros if it becomes clear that any dips won't stay much below the $1.45 line.


The RBA's accompanying statement bolstered expectations for a moderate slowdown in Asia, rather than a hard landing, that will bring inflation rates down has been attracting capital inflows and increasing bets on a second-half recovery in stocks.

Some markets though, particularly Japan, may be ripe for some profit-taking after jumping 4 percent in five sessions.

Risky assets have been slapped around in the first half of the year by concerns ranging from worries about escalating inflation in Asia, Japan's nuclear scare to surging commodity prices and the impact of the end of U.S. quantitative easing.

China's shares <.SSEC>, which have been at the vanguard of the latest rally in regional equities, dipped after rating agency Moody's said its local government debt burden may be 3.5 trillion yuan ($540 billion) larger than auditors estimated, putting banks on the hook for deeper losses.

Stock markets in Australia <.AXJO> and Japan <.N225> edged lower while the MSCI index of Asia-Pacific shares outside Japan <.MIAPJ0000PUS> dipped 0.3 percent, moving further away from a June 2 peak.

The index has been in a rising trend for the past two weeks.

Asian currencies rose after the People's Bank of China fixed the yuan's mid-point at a record high for the second consecutive day on Tuesday at 6.4650 against the dollar.

Government bond markets were fairly quiet with yields on ten-year U.S. Treasury notes edging lower to 3.16 percent, a rise of nearly 30 basis points since last Monday.

In credit markets, the Asia ex-Japan iTraxx investment grade index widened three basis points to 109-110 bps from early trade.

U.S. crude futures stayed close to the $95 per barrel line ahead of U.S. factory orders data later in the day.

Spot gold held steady near the $1,500 per ounce line while three-month copper contracts on the London Metal Exchange hugged the $9,425 a tonne line. (For the state of play of Asian stock markets please click on: <0#.INDEXA>))

(Additional reporting by Umesh Desai and Ian Chua in SYDNEY; Editing by Kim Coghill)