The U.S. dollar fell broadly on Thursday as better-than-forecast European economic data boosted equities and spurred appetite for risk, with a drop in U.S. lending rates putting additional pressure on the currency.
The dollar had earlier fallen to a seven-month low against the yen on downbeat comments from Federal Reserve Chairman Ben Bernanke the previous day, who said the U.S. economic outlook was unusually uncertain.
The subsequent release of strong European purchasing managers surveys, together with robust UK retail sales revived risk sentiment, putting the dollar under selling pressure.
The PMIs out of Europe have been very good and equity markets are rallying. I think this is a risk-driven move, said Paul Robson, currency analyst at RBS.
At 1130 GMT, the dollar was trading down around 0.8 percent versus a currency basket .DXY at 82.719 after slipping to a low 82.624.
Analysts said a fall in dollar lending rates was adding pressure to the currency, as three-month dollar Libor fell below 0.5 percent for the first time in two-months.
The dollar fell to a 2-month low versus the high-yielding Australian dollar with traders saying an option barrier had been targeted at $0.8880 en-route to the $0.8899 high. Further barriers were reported at $0.8900.
The euro rose over 1 percent from New York closing levels to reach a session high of $1.2877 having fallen to $1.2739 in early dealing. European stocks traded with gains of around 1.4 percent .FTEU3.
Attention focused on the release of European bank stress test results, due at 1600 GMT on Friday although some sources said they may be released earlier.
The euro has had a good run against the dollar in anticipation of the test results, rising to a 10-week high above $1.30 on Tuesday as, traders bet most of the 91 European banks being examined would pass.
Some in the foreign exchange market say the test results could be positive for the euro if they reveal no unpleasant surprises, but doubts linger over whether the checks are tough or transparent enough.
The market has certainly bought the rumor going into this week that the stress tests will be positive and people have been going long euro/dollar, with weak U.S. economic data making it look like a no-lose situation, said Lauren Rosborough, currency strategist at Westpac.
She said the euro was likely to see a short-lived rally after the results, which could turn to selling next week as market participants concluded after the tests that the problems facing euro zone peripheral countries have not gone away.
The dollar was down 0.4 percent at 86.78 yen after slipping to 86.35, extending losses in the wake of a 0.5 percent fall on Wednesday.
Traders said stop-losses were placed below the November low of 86.27, though strong bids were then said to be layered into 86.00.
The rise in the yen, which gained steeply on the crosses on Wednesday, has been hampered by caution that Japanese policymakers may try to talk it down as it nears a 14-year high around 85 yen per dollar hit last November.
Deputy Finance Minister Motohisa Ikeda said on Thursday Japan wants to avoid excessive rises in the yen, but market reaction was muted.
(Additional reporting by Jessica Mortimer, editing by Chris Pizzey)