A 2 percent fall in European share prices on concerns over the banking sector boosted the dollar, which tends to gain when investors shed risk assets. That also helped the yen, which firmed against the euro and dollar.

The euro fell about a full percent on the day, hitting a four-week low of $1.4627 according to Reuters data and reversing Monday’s gains made on firm manufacturing data.

“There’s less risk appetite, what with equities lower, so that’s supportive for the dollar,” said Marcus Hettinger, global currency strategist at Credit Suisse in Zurich.

Some attributed losses in banks shares and the euro partly to European Commission estimates of bank losses renewing anxiety over the sector’s health.

The EU Commission quoted results of stress tests in the banking sector, published in early October, which said losses could amount to 400 billion euros in 2009-10.

“Although several financial stress indicators are back at pre-crisis levels, the banking sector remains fragile,” the Commission said.

Bank shares suffered after disappointing results from UBS and a shake-up of UK banks. The DJ STOXX European bank index was down nearly 4 percent.

The euro fell 1.20 percent against the yen to 131.74 yen while the dollar dropped 0.3 percent against the Japanese unit to 89.88 yen.

Tokyo markets were closed on Tuesday for a national holiday.

Sterling tumbled to a one-week low against the dollar after the UK Treasury announced a shake-up of British banks, which raised concerns about the financial sector.

The government will raise its stake in Royal Bank of Scotland and Lloyds Banking Group raised a record 13.5 billion pounds ($22 billion) in a rights issue.

The dollar index rose to 76.817, its highest since early October.

Some traders said profit-taking on risk assets, already seen in equities, could materialise ahead of funds’ book-closings as the year-end approaches, and that this may offer an additional boost to the dollar.

“Year-end position liquidation could also prove disruptive to capital markets as investors crystallise this year’s gains,” said Geoffrey Yu, currency strategist at UBS in London.

Wary ahead of fed

Traders remained wary ahead of big schedule events this week — the U.S. Federal Reserve starts a two-day policy-setting meeting on Tuesday and the European Central Bank and the Bank of England also hold policy meetings later in the week. Key U.S. jobs data is due on Friday.

The Fed is expected to keep its benchmark interest rate unchanged near zero, where it has been since December.

Investors’ focus will be on the interest rate outlook given a raft of strong U.S. economic data, but many analysts say the Fed is unlikely to change the wording of its pledge to keep rates low for an “extended period”.

The Fed will announce its decision on Wednesday.

The Australian dollar fell more than 1 percent against the U.S. dollar to $0.8916, extending losses after the Reserve Bank of Australia raised its cash rate for the second month running, to 3.5 percent from 3.25 percent, as expected, but left markets guessing if it would hike again as soon as December.

Markets were still pricing in the chance of a 25 basis point increase in December, albeit a reduced chance.