The dollar staged a broad rally today to hit a 1-1/2-year high against a basket of currencies including the euro, fuelled by demand from banks for funding needs while investors unloaded highly-leveraged positions.
The US currency also found favour after Federal Reserve Chairman Ben Bernanke endorsed yesterday more government spending to stimulate the flagging US economy.
By contrast, the euro lost ground because of market expectations that there was scope for the European Central Bank to cut interest rates aggressively. Yen strength reflected underlying nerves on the global economic outlook.
While interbank lending has started to revive from a state of near-paralysis, the dollar and yen benefited as investors continued to liquidate highly-leveraged positions.
"The deleveraging story will continue and remain in place for quite some time," said Audrey Childe-Freeman, senior FX strategist at Brown Brothers Harriman in London.
"The other interesting thing coming through is the policy responses to the crisis. I think the US remains ahead on that front."
The dollar index, which measures the US currency's value against a basket of six currencies, rose to 83.646, its highest since March 2007. The euro hit its lowest since March 2007 at $1.3197, down around 1 per cent on the day.
Traders cited overnight speculation that banks needed more dollars to settle credit derivatives tied to the bankruptcy of Lehman Brothers. The dollar fell 1 per cent against the yen to 100.95 yen, while the euro dropped 1.9 per cent to 133.34 yen.
As financial markets regain some poise, analysts said the market's focus was switching to economic fundamentals and monetary policy.
Fed chief Bernanke said yesterday the economy was expected to be weak for several quarters and there was some risk of a protracted slowdown.
Fed policymakers meet next week, and economists and investors expect rates to be cut again from their current 1.5 per cent. The Fed and other major central banks eased monetary policy in coordination earlier this month.