Sterling hit its highest level in a quarter of a century versus the dollar on Tuesday, and the euro hit a record peak against the low-yielding yen as investors shopped for currencies with attractive yields.
The broadly defensive greenback gained some ground against the Swiss franc and euro. But it still hovered fairly close to record troughs versus the common currency, with worries about the US housing sector backing views that US borrowing costs would remain steady while those elsewhere will rise.
Investors were also reluctant to take bigger bets on the dollar before the US Independence Day holiday on Wednesday. Later on Tuesday, housing comes under the spotlight again with US pending home sales data due at 1400 GMT. "The theme has been very much one of dollar weakness reflected in the moves up in sterling and the euro recently," Lehman Brothers currency strategist Phyllis Papadavid said.
"The prospect of monetary tightening in those two (euro zone and UK) central banks is throwing support in the market's view to those currencies, while it's not clear what steer the Fed has on what the next monetary policy move is going to be," she added.
Sterling's gains gathered pace as interest rate expectations shifted sharply, after minutes from the Bank of England's latest policy meeting suggested that rates would rise this week, instead of August as previously anticipated.
The BoE meeting is expected to raise rates by 25 basis points on Thursday to 5.75 percent, which would be half a percentage point higher than US rates.
"We saw the 26-year high and that will continue ahead of the meeting - with the market saying that a hike to 6 percent at some stage later may be possible," CBCM currency strategist Antje Praefcke said, adding that the euro was also supported by expectations of eurozone monetary tightening.
By 1149 GMT, sterling stood at $2.0150, broadly steady on the day, after hitting a 26-year peak of $2.0197. Technical analysts were eyeing further upside, with next resistance seen at $2.0220/25.
The euro was trading around 166.56 yen, after scaling a record high of 167.19 yen, according to Reuters data. The dollar was steady at 122.47 yen, but remained near a three-week low touched on Monday. The Bank of Japan's index for the yen, after adjusting for the inflation rates of Japan and its major trading partners, dropped to a 22-year low of 93.4 in June from 94.9 in May.
BoJ Deputy Governor Toshiro Muto said on Tuesday the central bank has no precept schedule on interest rate adjustments, adding that moves would depend on improvements in the economy and prices. The BoJ is expected to hold rates at 0.5 percent at its meeting next week but a majority expect it to increase them to a 12-year high of 0.75 percent in August.
The European Central Bank is seen keeping rates steady at 4.0 percent at a policy meeting on Thursday but is expected to increase them twice more this year. The euro was down 0.2 percent at $1.3598, having earlier risen as high as $1.3634 - to within half a cent of record highs set in late April.
Calyon currency strategists said in a note to clients that they still believed the dollar would strengthen in the second half of this year, despite hawkish ECB expectations.
"The second half of 2007 will be a period of dollar strength as the US economy regains modest upward traction whereas expectations for eurozone growth are pared back in the face of earlier euro strength, ongoing monetary tightening and restraint on the fiscal front," they said.
Investors were also on alert for possible further action on Chinese interest rates after the country's central bank said it would strive to keep the economy from overheating and resort to a range of monetary policy tools to keep inflation in check.