The euro sank 0.5 per cent Tuesday as Cyprus threw its EU-IMF bailout in question when legislators rejected a controversial bank deposit tax meant to raise funds for the government.
The euro began to drop in US late-morning trade as it became evident that Cypriot lawmakers would turn back the tax, a linchpin of the 10 billion euro European Union-International Monetary Fund rescue plan for the island nation.
At 2100 GMT the euro was at US$1.2881, compared with US$1.2957 late Monday.
The safe-harbour Japanese currency also gained, with the US dollar dropping to 95.16 yen from 95.23 yen, and the euro moving to 122.59 yen from 123.41.
The US dollar's gain was also underpinned by some expectations that the Federal Reserve on Wednesday could deliver a slightly improved view of the US economy, which would be more bullish for the greenback.
Data released Tuesday on new housing starts in February was encouraging, with the pace up 28 per cent from a year earlier, underscoring strength in the US real estate sector.
The Federal Open Market Committee, the Fed's policy board, "may sound more upbeat this time around amid the more broad-based recovery" in the US, said David Song of DailyFX.
"We may see a growing number of Fed officials scale back their willingness to expand the balance sheet further as growth and inflation picks up," he said, referring to the Fed's quantitative easing (QE) program of bond-buying.
But not all analysts were confident in that picture. Neal Gilbert of GFT said that Fed Chairman Ben Bernanke had shown no sign yet of seeing growth strong enough to reel in QE, which would tighten interest rates.
"In the previous two FOMC decisions, the US dollar has been hammered on the back of Bernanke outright dismissing the idea that QE could be lessened any time soon, Gilbert said.
"And the same thing could happen tomorrow."
The pound was lower against the US dollar, trading at US$1.5095 compared with US$1.5107 late Monday.
The US dollar edged higher against the Swiss franc, to 0.9467 franc from 0.9462 franc.