The US dollar posted limited gains on Thursday but remained below its six-week high, as growing optimism that Washington is nearing an agreement with Tehran to end the war in the Middle East capped further advances in the US currency.
US President Donald Trump said on Wednesday that negotiations with Iran had entered their final stages, while also warning that additional strikes could be launched if Tehran refuses to agree to a deal.
The dollar, considered a safe-haven asset by investors, rose 0.1% against the Japanese yen to 159.06 yen after recording its first decline versus the Japanese currency in eight sessions on Wednesday.
The yen also received additional support after hawkish comments from Bank of Japan board member Junko Koeda, who said the central bank needs to continue raising interest rates as underlying inflation stabilizes near the 2% target.
Meanwhile, the euro fell 0.2% to $1.16005 after dropping on Wednesday to its weakest level since April 7 at $1.1583 before rebounding.
Pressure on the European currency intensified after data showed French economic activity contracted in May at the fastest pace in five and a half years.
The French PMI data was extremely weak, but the European Central Bank still appears determined to raise rates, said Kenneth Broux, Head of FX and Rates Research at Socit Gnrale, explaining the euros weakness.
Traders are also awaiting the release of the eurozone composite PMI data later today.
The British pound also slipped 0.1% to $1.3421.
The US Dollar Index, which measures the greenback against a basket of major currencies, rose 0.2% to 99.295 points, though it remained below Wednesdays peak of 99.472 points, the strongest level since April 7.
Joseph Capurso, Head of International and Sustainable Economics at Commonwealth Bank of Australia, said safe-haven flows reversed following positive news regarding the war with Iran.
However, he added that the United States could still resort to military escalation to strengthen its negotiating position, despite domestic political incentives pushing toward peace.
Investors remain focused on the inflationary impact of higher energy prices as the Strait of Hormuz continues to face partial shipping disruptions.
Currency analysts at Commerzbank said some central banks may view the current inflation shock as temporary if the strait reopens in the coming days, but warned that such an assessment would be flawed because it overlooks the decline in purchasing power.
They added that currencies could benefit in countries where central banks are slower to label rising prices as temporary, while the possibility of tighter monetary policy remains in place.
Minutes from the Federal Reserves April meeting, released Wednesday, also showed growing concern among policymakers regarding inflation, with a larger number of officials becoming open to the possibility that further interest rate hikes may be necessary.
In other markets, the Australian dollar declined after an unexpected rise in unemployment to the highest level since 2021, reducing expectations for additional rate hikes from the Reserve Bank of Australia.
The Australian dollar fell 0.55% to $0.71105 after traders scaled back expectations for further monetary tightening this year.
Ryan Wells, economist at Westpac, said expectations for rates to remain unchanged at the June meeting are now high conviction, though he noted that inflation remains the central banks biggest challenge.