NEW YORK (Reuters) - The euro declined to its lowest level against the dollar in six weeks on Wednesday as data showing an unexpectedly large contraction of the euro zone economy raised expectations for more monetary easing by the European Central Bank.
The dollar again rose to a 4-1/2-year high against the yen as investors debated the outlook and policies affecting the U.S. economy against those affecting Japan, though it pared gains midway through the New York session to trade flat and remained there for the New York trading afternoon.
While it has been the yen that investors have focused on in recent days, the euro dominated on Wednesday as it fell for a fifth straight session against the greenback. Data showed Germany's economy crept back into growth at the start of the year, but not by enough to stop the overall euro zone economy from contracting for a sixth straight quarter. France, meanwhile, slid into recession.
By contrast, the United States is showing signs of a recovery, underpinning expectations that the Federal Reserve may wind down its asset-purchasing program by the end of the year.
The dollar briefly pared gains after data showed manufacturing activity in New York state contracted unexpectedly in May as new orders and shipments of finished goods fell, but that was not enough to deflect the overall trend.
Inflation data showed U.S. producer prices recording their largest drop in three years in April, pointing to weak inflation pressures that should give the Fed latitude to keep monetary policy very accommodative.
"The U.S. economy appears to be improving, albeit slowly, while the euro zone GDP data overnight reinforced expectations of additional easing from the ECB, either through lower interest rates or through nonstandard measures such as negative deposit rates," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington, D.C.
"That contrasts with a growing notion that the Fed is inching closer to an exit strategy," he said.
The euro fell as low as $1.2842, its lowest since April 4, and last traded down 0.3 percent against the dollar at $1.2879. Against the yen, the euro last traded at 131.82 yen, down 0.4 percent on the day.
European Central Bank officials have said they could ease monetary policy further, and perhaps even take the deposit rate - the level at which banks park their surplus cash with the central bank - below zero if the economy slowed.
A cut in the deposit rate would make holding euros unattractive and could lead to a broad selloff.
Concerns about the euro zone's recession trumped positive news out of Greece, with 10-year Greek government bond yields tumbling to their lowest in nearly three years, one day after Fitch upgraded the country's sovereign credit ratings.
Separately, the International Monetary Fund's executive board approved a $1.3 billion, three-year loan to Cyprus on Wednesday, part of a larger international bailout to help the Mediterranean country avoid defaulting on its debt.
The dollar earlier in the global session rose as high as 102.76 yen on Reuters trading platform, its highest since October 2008 and the fifth rise in as many days. But dollar gains were pared during the North American session on falling U.S. Treasury bond yields. Yields move inversely to price.
The dollar last traded at 102.35 yen, little changed on the day, according to Reuters data.
Dollar/yen "is a one-way trade and no one knows what to do," said George Dowd, head of the foreign exchange desk at Newedge USA LLC in Chicago. "It's difficult to buy at 102.50 but if you don't buy you miss it. There has been no pullback since late March."
The dollar is now up 18.1 percent for the year against the yen. Though there are seven months until the year closes, if gains were to hold at this level it would be the best year since 1979 when the dollar rose 23.68 percent against the yen.
Some $4.92 billion in euros changed hands on Wednesday on Reuters Dealing and $3.23 billion in yen.
Reporting by Nick Olivari and Julie Haviv; Editing by James Dalgleish