The rupee dropped 10 paise to close at 71.34 against the US dollar on Thursday as heavy selling in domestic equities, unabated foreign fund outflows and rising crude oil prices kept investors edgy.

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Forex traders said investors also turned cautious after the US Federal Reserve dimmed hopes of further rate cuts.

At the interbank foreign exchange market, the local unit opened on a strong note at 71.36 and shuttled between a high of 71.06 and a low of 71.37. It finally finished at 71.34, lower by 10 paise over its previous close of 71.24.

"Since the morning, rupee has been tracking the move in crude. Overnight drop in oil led rupee to appreciate. However, the escalating tensions in Middle East limited the gains in rupee," said Rahul Gupta, Currency Research Head, Emkay Global Financial Services Limited.

Gupta added that the "market was disappointed with Fed's mixed outlook".

In line with market expectations, the Federal Open Market Committee lowered the policy interest rate by 25 basis points to a target range of 1.75 to 2.0 per cent, but dimmed hopes for subsequent rate cuts as it took a cautious approach to further reductions in borrowing costs.

Brent futures, the global oil benchmark, soared 2.14 per cent to $64.96 per barrel after Iran warned of an "all-out war" if it is targeted in the aftermath of the drone attacks on Saudi Arabia's oil infrastructure, further pushing up tensions across the Persian Gulf.

Heavy selling in domestic equity markets and sustained foreign fund outflows also weighed on the domestic currency, forex traders said.

The 30-share BSE Sensex ended 470.41 points, or 1.29 per cent, lower at 36,093.47. Similarly, the broader NSE Nifty plunged 135.85 points, or 1.25 per cent, to settle at 10,704.80.

Foreign institutional investors (FIIs) offloaded shares worth a net Rs 892.52 crore on Thursday, according to provisional exchange data.

The 10-year government bond yield was at 6.64 per cent.

The Financial Benchmark India Private Ltd (FBIL) set the reference rate for the rupee/dollar at 71.3132 and for rupee/euro at 78.9052. The reference rate for rupee/British pound was fixed at 89.0626 and for rupee/100 Japanese yen at 65.90.