The euro lost momentum on Tuesday after hitting a lifetime peak against the low-yielding Japanese yen, with sentiment hurt after a surprising fall in a measure of German investor confidence.
The ZEW economic sentiment index, a measure of German investor sentiment on the outlook for the euro zone's largest economy, fell in June to 20.3 from May's 24.0, sending the euro to session lows against the dollar and well away from a record peak hit earlier above 166 yen.
Analysts said that although the ZEW index did not materially alter near-term expectations for at least one more European Central Bank rate hike this year, the surprise drop dented sentiment.
The ZEW spoilt the party. The data wasn't dramatically bad but it was weaker than expected. With euro zone data we've become accustomed to getting stronger readings, so a weak reading is bad news and that's why the euro is back below $1.34, CIBC World Markets economist Audrey Childe-Freeman said.
The yen remained mired near 4-1/2 year troughs versus the dollar, with sentiment still positioned against it as investors continued to favor higher-return currencies.
The yen has weakened across the board since the Bank of Japan last week kept interest rates on hold at 0.5 percent and Governor Toshihiko Fukui said he had no preconceived ideas about a future rate rise, dampening expectations of a hike in July.
Most market players are looking for the BOJ to raise rates to a 12-year high of 0.75 percent in August, but such a move is not expected to dull the allure of carry trades -- borrowing cheaply in low-yielding currencies to buy higher-yielding assets.
By 0956 GMT the euro was down 0.2 percent on the day at $1.3388, while it also fell 0.2 percent to 165.56 yen after hitting a record peak of 166.11, according to Reuters data.
The dollar was steady at 123.65 yen, near its 4-1/2-year high of 123.75 yen set the previous session.
The high-yielding Australian and New Zealand dollars, among the most popular for carry trades, hovered near 16-year and 20-year highs respectively against the yen.
KOJI SHRUGGED OFF, US DATA EYED
The market shrugged off comments from Japanese Finance Minister Koji Omi that he was watching currency rates carefully and that economic fundamentals are favorable, which are firmer than his usual remarks that exchange rates should reflect economic fundamentals.
The euro has strengthened in recent sessions as market players see the European Central Bank lifting rates twice more to 4.5 percent, while the U.S. Federal Reserve is now widely seen keeping rates on hold at 5.25 percent rather than cutting them.
Some soft underlying U.S. inflation, consumer sentiment and housing data have dimmed the outlook for U.S. rates and growth slightly.
Market players will now look to figures on U.S. housing starts and building permits for May later in the day to see if a downturn in the housing market, a soft spot for the economy, has finally bottomed out.
Economists forecast that housing starts would slow to an annualized 1.480 million in May from 1.528 million in April.
With U.S. rate futures now implying no material change in US rates out to early 2009, softer housing numbers will weigh on the dollar, RBC Capital markets said in a note to clients.