Commodity-linked currencies such as the Australian dollar regained ground, but the market remained nervous that the withdrawal of liquidity as economies recover and central banks focus on inflation risks could prompt investors to unwind positions in perceived riskier assets.

Speculation that China will continue to remove some of its measures will keep the forex market on its toes. No doubt sentiment will swing between risk aversion and appetite depending on rhetoric from policymakers, said Stuart Bennett, currency analyst at Calyon.

By 1216 GMT (7:16 a.m. EST), the euro had climbed more than half a percent on the day to $1.4804, according to Reuters data, its highest since December 16. Traders cited demand from Asian sovereign names boosting the single European currency.

The euro recovered from a slide early in the European session after data showed the German economy contracted by more than expected in 2009.

The dollar index, which tracks the performance of the greenback versus a basket of six major currencies, fell around 0.4 percent to 76.605 .DXY, its lowest since mid-December.

The yen fell broadly, paring gains made on Tuesday after China's central bank raised banks' required reserves ratio - a move which prompted investors to unwind yen-selling positions.

The dollar rose 0.2 percent to 91.16 yen, after falling to 90.73 yen on Tuesday. The euro was up 0.7 percent to 132.82 yen, after falling 1.4 percent on Tuesday.

The Australia dollar, which fell on Tuesday with other commodity-linked currencies on fears over Chinese growth, recovered on Wednesday.

The Aussie climbed 0.8 percent to 84.35 yen, after its biggest daily drop in eight weeks on Tuesday.

It also rose 0.5 percent to $0.9250, after falling more than 1.2 percent on Tuesday, with traders noting sovereign demand facilitating the move.

Ian Stannard, currency strategist at BNP Paribas in London, said he remained cautiously bullish on commodity currencies in the near-term, but warned that further signs that China may need to tighten monetary policy would need to be closely watched.

Chinese inflation data next week would be important, he said, adding a strong number would likely heighten market expectations of more aggressive tightening from China.


Sterling touched a near one-month high of $1.6285 after Bank of England policymaker Andrew Sentance said in a newspaper interview published on Wednesday the central bank was close to holding back on stimulus.

The pound was also boosted after UK industrial production data came in stronger than expected.

The Swiss franc briefly dipped against the euro to 1.4804 francs as traders cited talk of bids from the Bank for International Settlements (BIS), which sometimes acts in the currency market for individual countries' central banks. The euro was last up 0.3 percent at 1.4780 francs.

Market players will keep an eye on U.S. corporate earnings and the fallout from a potential U.S. government levy on banks. The chief executives of Wall Street's biggest firms are scheduled to testify before Congress about the financial crisis.

(Additional reporting by Tamawa Desai; Editing by Nigel Stephenson)