The dollar declined versus the Japanese yen and the euro Wednesday as investors reassessed a rally that had sent the greenback to its highest level in more than a month, but pared those losses on fresh worries about sovereign debt.
The dollar's loss against its rivals, including the British pound, moderated after Standard & Poor's also lowered its outlook on Spain's credit rating, adding to concerns that sovereign credit problems have not abated after Greece's rating was lowered on Tuesday.
Also, Moody's Investors Service said it may downgrade government-sponsored issuers in the United Arab Emirates, which are either owned by the U.A.E. or Abu Dhabi.
The dollar index (DXY), a measure of the greenback against a basket of major currencies, fell to 76.094 from 76.225 in late North American trading Tuesday.
The decline reverses a rally in the greenback that sent the index in the past week to its highest since Nov. 3. It had gained 2.2% since late Thursday, the evening before a surprisingly positive U.S. jobs report caused a shift in expectations of when the Federal Reserve could raise rates, giving a lift to the U.S. dollar.
The euro traded at $1.4724, up from $1.4699 late Tuesday.
The dollar fell to 87.83 yen from 88.40 yen on Tuesday.
The yen and the greenback both gained in Asian trade on safe-haven flows in the wake of Tuesday's downgrade of Greece's credit rating to BBB+ by Fitch Ratings.
There is no risk Greece will default on its debt, Greek Finance Minister George Papaconstantinou said Wednesday.
The dollar move, however, was reversed on a "massive short squeeze" in early European action, said Boris Schlossberg, director of currency research at GFT.
That means traders that had shorted the dollar -- bets the currency would keep falling -- had hit a level that made them unwind those positions.
"The gyrations are a sign that liquidity is clearly leaving the market as end of the year holidays approach and volatility could increase considerably over the next several weeks if the market faces any further exogenous shocks," he said.
In a note, Merrill Lynch expects the dollar to strengthen versus the euro next year as the greenback becomes less correlated with investors' willingness to move into riskier assets, including equities and emerging markets. The euro will fall to $1.28, strategists at the firm forecast.
U.K. pre-budget report
The British pound bought $1.6218, giving up earlier gains and down from $1.6283 on Tuesday.
British Chancellor of the Exchequer Alistair Darling said the government will need to borrow more than previously stated, but the amount was less than analysts were bracing for.
Darling, Britain's finance minister, also outlined measures designed to cut the nation's deficit down in coming years from a level equal to around 12.4% of gross domestic product over four years.
"The threat of a credit downgrade in the U.K. may not have been taken too seriously by the market this year, but unless the U.K. government can prove good progress towards deficit reduction, anxiety will likely heighten and sterling could post further losses," said Jane Foley, research director at Forex.com.
"Today's pre-budget report should thus offer some concrete signs that the government is taking fiscal responsibility seriously," she said.
Currency investors' reaction to disappointing economic data in Japan was muted since the figures were largely expected.
Revised gross domestic product data from the Cabinet Office showed Japan's economy grew just 0.3% in real terms in the July-September period from the previous quarter -- less than the on-quarter rise of 1.2% in the preliminary data, and even worse than economists' grim consensus expectations.
On Tuesday, the dollar rose to its highest level against the euro in five weeks and gained against other major currencies, as worries about high levels of debt in Greece and Dubai led investors to buy assets that would offer protection in a crisis.
By Deborah Levine
Copyright 2009 Dow Jones & Company, Inc.