Currency drops as Fed rate rise prospects reassessed

The dollar fell against a basket of currencies on Wednesday as investors re-evaluated whether the U.S. Federal Reserve will raise interest rates this year, which also sent the higher-yielding Australian dollar to a three-month high.

U.S. Treasury yields fell after the productivity report suggested the economy may not be growing as quickly as anticipated, prompting investors to cut long-term inflation expectations. According to CME's Fedwatch, investors have trimmed chances of a rate rise in December 2016.

The dollar was down 0.5 percent at 101.40 yen, having gone as high as 102.66 on Monday on the strong nonfarm payrolls data. The euro rose 0.2 percent to $1.1142, touching a 5-day high of $1.1156.

The dollar index dropped 0.35 percent to 95.861.

"The release of the third consecutive decline in quarterly U.S. productivity - the worst run since at least 1980 - does not bode well for the prospects for the dollar," Morgan Stanley head of currency strategy, Hans Redeker, said.

The Australian dollar advanced to a 3-month peak of $0.7708 , buoyed this week by Australia's relatively high yields and stronger investor appetite for risk.

The U.S. dollar's weakness also gave struggling sterling some respite. The pound was up 0.2 percent at $1.3030, recovering from the $1.2956 level it hit on Tuesday, its lowest since July 11.

The pound took a knock on Tuesday after Bank of England policymaker Ian McCafferty said more monetary easing was likely to be needed if the UK's economic decline worsened.

"The pound was oversold and it benefited from some market correction, with the bounce also benefiting other currencies against the dollar. The market is thin at the moment and each move tends to be exaggerated," IG Securities forex analyst in Tokyo, Junichi Ishikawa, said.

Trading volumes are expected to be relatively light this week with many traders and investors on a summer break.