The dollar tumbled against the euro Tuesday after higher-than-expected German wholesale inflation figures were compounded by fresh record highs for oil, which will keep pressure on prices, dealers said.
They said comments from the head of a leading German research institute said the European Central Bank would likely raise interest rates if inflation remained high added to the positive tone.
The single European currency in late-day deals was at 1.5672 dollars against 1.5509 late Monday in New York.
The dollar was meanwhile at 103.66 yen, down from 104.31.
Wolfgang Franz, a prominent academic and president of the ZEW research institute, said the ECB might be forced to tighten credit in the coming months in the face of rising inflation.
Earlier in the day, the ZEW institute found that the German economy was being hampered by the strength of the euro and higher food and energy prices.
"Franz explained that, in his view, the ECB should keep rates constant until the financial market crisis ends but that the ECB may then need to raise rates to fight inflation," said Holger Schmieding, analyst at Bank of America.
"As Franz seems to hope that the financial crisis could end soon, he thus seems to believe in higher ECB rates in the foreseeable future," Schmieding added.
The ZEW institute said its closely watched indicator of economic sentiment fell by 0.7 points to minus 41.4 points after minus 40.7 points in April. Economists had expected an improvement to minus 38 points.
"On the one hand, economic expectations for the next six months for the United States and consequently also for the German export industry have increased considerably. On the other hand, inflationary risks remain high. This should negatively affect private consumption in Germany," the ZEW said.
Prior to the release of the ZEW data, the euro had been buoyed by a report on German producer price inflation that cemented market expectations the ECB would not be cutting interest rates any time soon.
Figures from the Federal Statistics Office showed that producer prices in Germany rose 1.1 percent in April from March for a 5.2 percent annual gain.
Both were higher than expectations.
The ECB has kept its benchmark rate at a six-year high of 4.0 percent since last June and is widely anticipated to maintain its rate until the end of the year as inflation concerns persist.
The single currency has also been underpinned of late by comments from the ECB making clear its preoccupation with inflation.
ECB President Jean-Claude Trichet last week said the central bank had to be "extraordinarily attentive" to inflation and that it was "paying particularly close attention to wage negotiations in the euro area."
A mixed set of US inflation figures had no effect on the rise of the euro. US producer prices rose just 0.2 percent in April, well below forecasts for a bigger 0.4 percent gain.
The news was tempered, however, by evidence of rising prices at the core level, which will concern rate-setters at the US Federal Reserve.
Core PPI was above expectations, rising 0.4 percent on the month against forecasts for a 0.2 percent rise, the figures showed.
In London on Tuesday, the euro changed hands at 1.5672 dollars against 1.5509 late on Monday, at 162.44 yen (161.76), 0.7954 pounds (0.7955) and 1.6253 Swiss francs (1.6341).
The dollar stood at 103.66 yen (104.31) and 1.0371 Swiss francs (1.0535).
The pound was at 1.9706 dollars (1.9489).
On the London Bullion Market, the price of gold jumped to 914.50 dollars per ounce from 906.50 dollars late on Monday.
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