The greenback rose to a 2-month high of 1.4330 against the single currency n a 2 & 1/2 month high of 2.0101 versus the British pound on Monday on speculation that the U.S. Federal Reserve may not cut interest rates in 2008 as aggressively as previously anticipated. However, the dollar retreated on profit-taking and partly due to falling U.S. stocks together with the release of a weaker-than-expected Empire States manufacturing index.

Dollar extended last Friday's gain in European session, as investors took the surprisingly big rise in U.S. consumer prices (released last week) as a sign that there is less of a certainty that Fed will cut rates again in January. Interest rate futures are reflecting about a 70 percent implied chance of a quarter-percentage-point interest rate cut in January, down from around 100 percent last week.

There were also comments from the San Francisco Fed that the credit crisis, falling home prices and high energy costs have increased U.S. vulnerability to a recession, and hence there appears to be a significant chance of registering at least one quarter of negative GDP growth.

On the data front, factory performance in New York states fell to a 7-month low in December, according to the Federal Reserve Bank of New York's Empire State manufacturing index, which dropped from 27.4 in November to 10.3, well below economists' forecast of 20.0.

Although the release of an unexpected rise in U.S. long-term capital inflows in October to $114 billion, well above September's $15.4 billion inflow, brought some support to the buck, the greenback slipped again in late trading as the Dow declined over 170 points on worries that rising inflation and sign of weak holiday retail sales would hurt the U.S. economic outlook.

The euro rebounded in New York to 1.4400 and cable also traded higher to above 2.0200. The greenback retreated against the Japanese yen to 112.83 on unwinding in carry trades.

Mixed comments from U.S. Treasury Secretary Paulson had little impact on the forex markets. He said turmoil in credit markets and housing downturn take time to work through but he played down the risks of recession and he said U.S. inflation was in check.

Tuesday's data releases include U.K. November CPI and RPI data, EU trade balance, Canada November CPI. U.S. November building permits and housing starts data are also due out at 13:30GMT.