LONDON: The dollar rose against the euro and growth-linked currencies on Thursday after the US Federal Reserve disappointed investors who had expected it to opt for more aggressive easing - a move that would have boosted appetite for riskier currencies.
The euro came under fresh pressure after data showed Germany's private sector shrank in June for the second month running, with manufacturing activity hitting a three-year low.
This suggested Europe's largest economy may contract in the second quarter as the euro zone debt crisis intensified, and offset data from France which showed a slowdown in business activity there had eased.
Overall, the data made grim reading and kept alive expectations the European Central Bank will cut interest rates, offering investors a fresh excuse to sell the euro.
"The market has got used to terrible numbers from the euro zone. The focus is now on the Spanish auction, but the medium term outlook for the euro remains weak," said Geoff Kendrick, currency strategist at Nomura.
The euro dropped 0.4 percent to $1.2650, having hit a high of $1.2744 on Wednesday. Bids from sovereign investors and macro funds were cited below $1.2620. Offers were reported above $1.2700 and stop-loss orders above $1.2720, traders said.
The dollar regained lost ground after the Fed stopped short of launching a more aggressive programme of buying bonds outright, or QE3, which some in the market had expected.
The dollar index, a measure of the greenback's performance against a basket of currencies, rose 0.13 percent to 81.717. The dollar rose 0.2 percent to 79.63 yen, getting some support after US Treasury yields edged up on Wednesday.
The Fed expanded its "Operation Twist", under which it sells short-term securities to buy longer-term ones to keep long-term borrowing costs down, by $267 billion. The programme, which was due to expire this month, will run until the end of the year.
Analysts said the dollar's outlook was clouded, with more players likely to position for fresh Fed stimulus after central bank downgraded its US growth forecast.
SPAIN IN FOCUS
Many analysts said the Fed was probably saving ammunition given the risk the euro zone crisis could deteriorate in coming weeks as borrowing costs in peripheral countries remain high.
Spain's borrowing costs are expected to hit new highs at a debt auction on Thursday, a few hours before it sheds light on the state of its banks and possibly makes a formal request for funds to bail out the sector.
The single currency got a lift on Wednesday after German Chancellor Angela Merkel said both of Europe's bailout programmes included mechanisms for buying state debt on the secondary market. But she stressed this was a "purely theoretical" question and was not being discussed.
Meanwhile, growth-linked currencies came under pressure, digesting the Fed decision and weak Chinese data. The Australian dollar fell 0.5 percent to $1.0141, retreating from a seven-week high of $1.0225 hit on Wednesday.
The Aussie dollar hit an intraday low after a private-sector survey showed China's factory sector contracted for an eighth successive month in June, with export orders at their weakest since early 2009.
"The indications from China at least, are that they are taking the slowdown a bit more seriously," said Todd Elmer, currency strategist at Citi in Singapore.
If the weakening in Chinese data is sustained, market players may start to question the effectiveness of Chinese policy steps to support its economy, Elmer said.
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