The U.S. dollar fell on Tuesday on speculation the Federal Reserve may attempt to keep debt costs low by reducing expectations for higher interest rates at the conclusion of its meeting on Wednesday.

Higher consumer and business borrowing costs would jeopardize or delay a U.S. economic recovery as the Fed does everything in its power to ensure a return to growth.

The euro jumped more than 1 percent to trade above $1.41 as financial markets also awaited the auction results of a record $104 billion in U.S. debt issuance this week.

A $40 billion auction of two-year Treasury notes on Tuesday saw a high yield of 1.151 percent, the highest since November 2008, with strong demand. Low demand for remaining auctions would still raise concerns about how the United States will finance its huge deficits.

The Fed's policy-setting Federal Open Market Committee is scheduled to make its policy announcement on Wednesday at the end of a two-day meeting, at about 2:15 p.m. With no move on rates expected, investors will focus on what the Fed says about the economic outlook and its debt-buying program.

Higher interest rates would be deadly, said Axel Merk, portfolio manager of the Merk Hard and Asian Currency Funds, based in Palo Alto, California, in an interview in New York. The recovery of the mortgage market is completely reliant on lower rates. If rates were to rise further, this recovery would go back in a tailspin.

In late afternoon trading in New York, the euro rose 1.6 percent against the dollar to $1.4075 after hitting a session peak of $1.4106, according to Reuters data. It was the biggest one-day percentage gain since May 8, at current prices. It rose as high as $1.4109 on electronic trading platform EBS.

Investors were also buying euros ahead of the European Central Bank's first-ever one-year refinancing operation on Wednesday, aimed at getting banks lending again.

It could signal the last vestiges of the ECB's version of quantitative easing, which is always euro-positive, said CMC Markets analyst Ashraf Laidi.

The ICE Futures U.S. dollar index, which tracks the value of the greenback against a basket of major currencies, fell 1.2 percent to 79.803 .DXY. It was the biggest one-day drop since May 29 at current prices, according to Reuters data.

The dollar has come under pressure in recent weeks as more upbeat U.S. economic data fueled hopes that a global economic recovery was on track. However, an outlook by the World Bank on Monday stirred worries about global growth, pushing stocks sharply lower and reviving safe-haven flows into the greenback.

Concerns about reserve diversification away from U.S. assets also weighed on the dollar on Tuesday after Moody's said one risk to the United States' AAA rating would be if there were a severe challenge to the dollar as the main reserve currency.

It said the U.S. rating is safe unless the government is unable to bring debt back down.


An improved tone on Wall Street, the day after the worst one-day loss in two months, encouraged investors to be a little less risk averse earlier in the session.

The dollar has tended to fall when risk sentiment improves as investors move money away from safe-haven investments into riskier ones.

The dollar also fell against the yen, extending losses after an industry survey showed sales of previously owned homes in the United States rose less than expected in May. The data pointed to a sluggish recovery from the severe economic recession.

The dollar last traded 0.7 percent lower at 95.21 yen, after earlier touching a three-week low of 94.88 yen, according to electronic trading platform EBS.

Adding to support for the euro were comments by European Central Bank Governing Council member Axel Weber on Tuesday that he saw no need for further policy measures at the moment to get the economy back in shape.

CMC'S Laidi said Weber's remarks were positive for the euro as they dampen the possibility of quantitative easing.