NEW YORK (MarketWatch) -- The U.S. dollar fell sharply against other major currencies, including the Japanese yen, Monday ahead of tomorrow's Federal Reserve decision on interest rates.
The dollar index a measure of the greenback against a trade-weighted basket of six currencies, dropped 0.7% to 82.56, down from 83.662.
The euro rose 1.6% at $1.3574, up from $1.3374. The British pound surged 1.4% to $1.5153 from $1.4933.
"Repositioning in thinner markets ahead of year-end and to some extent the FOMC [Federal Open Market Committee] meeting tomorrow is likely accounting for some dollar selling," said currency strategists at Brown Brothers Harriman. Weekly data suggested that short-term players continued to reduce long dollar positions in the latest week, they said.
The Federal Reserve is widely expected to cut its benchmark interest rates by half a point to 0.5% on Tuesday.
In economic news, manufacturing activity in the New York area contracted at a record pace in November, the New York Federal Reserve Bank said Monday. The bank's Empire State Manufacturing index fell to negative 25.8 in December from negative 25.4 in November.
The U.S. dollar lost ground Monday as rising risk appetite lifted Asian and European equities.
Asian markets shrugged off a steeper-than-expected drop in the Bank of Japan's Tankan index, a closely-watched business-confidence gauge. Tokyo's Nikkei jumped more than 5%. See Asia Markets.
The rebound took back most of the losses suffered in Tokyo Friday, when Asian equities plunged following the collapse in the U.S. Senate of a legislative package to bail out the auto industry.
The Bush administration later indicated it would weigh stepping in to provide a lifeline to the automakers. That allowed U.S. stocks to close higher Friday and set the stage for Monday's rebound in Asia, said strategists at BNP Paribas.
Although questions remain about how the administration will fashion a rescue, investors were willing to put on new positions, they said.
But the strategists urged caution in buying the euro or the British pound versus the dollar. They warned that the Fed's expected half-point rate cut this week, along with the potential for quantitative-easing measures, could lead U.S. asset markets to outperform, supporting the dollar.
The dollar also fell 1% Monday against the Japanese yen to trade at 90.31 yen. On Friday, the dollar plunged to a 13-year low versus the yen.
The BOJ Tankan survey found confidence among large manufacturers fell at its fastest pace since 1974, signaling a deepening recession for the world's second-largest economy. See full story.
Strategists at Commerzbank said the data underscored the dilemma faced by Japanese authorities.
With the BOJ's official interest rate at 0.3%, there is little room for further monetary easing, they said. And fiscal stimulus measures may not have the desired effect due to the tendency of Japanese consumers to save rather than spend.
"Against this backdrop, Japan might return to a policy of intervention in the currency market to end the recent surge in the value of the yen," the Commerzbank strategists wrote. "Therefore, further yen strength is not very likely."
The British pound continued its historic slide versus the European single currency Monday.
The euro traded at 90.10 pence, up 0.8% on the day and above the 90-pence level versus sterling for the first time in the single currency's nearly 10-year history. A move to 90.20 pence would match the equivalent of the German mark's 1995 high versus the pound.
The pound notched a series of all-time lows against the euro last week.
"Risk aversion, weakening economic data, falling cyclical support and the requirement to fund a current account deficit has weighed on sterling," wrote Naeem Wahid and Ashley Garvin, strategists at HBOS.
They expect the euro to trade between 85 and 95 pence over the next six months.
