The dollar steadied below a recent seven-week high against the euro on Monday, following Friday's call for a strong dollar from U.S. Treasury Secretary John Snow.
Investors focused on Snow's comments, made in a series of television and radio interviews, that the United States wanted to "do things", including cutting its deficit, to support the currency's strength.
This raised talk that President George W. Bush could introduce substantial cuts in the 2006 budget deficit and diminish a key negative for the long-suffering dollar.
"What Snow said was that there is an active intention to do something about the dollar," said Trevor Dinmore, currency strategist at Deutsche Bank in London.
"We now have rhetoric that does indicate substantial budget cuts, but the market will want to see the details of the plan which will be submitted in February."
Since the start of this year the dollar has already gained more than three percent and risen six cents from record lows set against the euro in late December, as investors focused on expectations for future interest rate hikes in the U.S.
At 0850 GMT the dollar traded a third of a percent down on the day at $1.3093.
The dollar also traded 0.2 percent down on the day at 104.55 yen.
Trading was thin earlier in the session because Japan was on holiday.
European Central Bank President Jean-Claude Trichet holds a news conference at approximately 1100 GMT after the regular meeting of the central bankers from Group of 10 and emerging nations in Basel.
Later in the day, the Federal Reserve Bank of Kansas City releases its December manufacturing index at 1600 GMT.
Two Fed officials were also due to speak, including Federal Reserve Board governor Edward Gramlich at 1515 GMT and Fed Bank of Atlanta President Jack Guynn at 1700 GMT.
STRUCTURAL CHANGES?
The U.S. budget deficit has been a key driver of the dollar's multi-year decline, along with the country's growing current account deficit and investors' worries that the U.S. might find it difficult to plug that shortfall.
And the apparent lack of concern from the U.S. administration about the dollar's decline gave additional momentum to dollar selling last year. It also sparked criticism from other major economies which faced competitive pressures from a weakening dollar.
But last week, Snow omitted references he had made in earlier comments on the dollar that the market should determine its value. The omission this time left some analysts questioning whether the U.S. indeed wanted the dollar to weaken.
"U.S. rhetoric on its three core policies -- interest rates, fiscal spending and exchange rate -- is likely to be dollar-supportive to counter criticism that the U.S. is covertly pushing for a weak dollar," Singapore-based DBS Bank said in a report.
"The euro and other major currencies are at risk of more downside correction, even if they get a relief from short-covering after last week's bloodbath."
Still, analysts maintained the longer term outlook for a weaker dollar because of the United States' struggle to reduce its current account deficit and to cut its budget deficit while the Bush administration pushes for permanent tax cuts.
"That smacks of inconsistency ... It will be extremely difficult for the Bush Administration to make meaningful inroads into the budget deficit without scaling back in some way recent tax reductions, especially if reforms to social security are to be pushed through at the same time," said Craig Ferguson, senior currency strategist at ANZ Investment Bank.