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Analysts said the claims data, coupled with the revision of fourth-quarter economic growth estimates were enough to revive the debate on whether the world's largest economy was in or close to a recession, a factor which would diminish the chances of raising interest rates later this year.
"The dollar is dropping across the board on a double data whammy," said Ashraf Laidi, chief strategist at CMC Markets in New York.
"These reports are a reminder that the dollar's fundamental woes are not limited to banking writedowns and high oil prices, but also a manifestation of weak macroeconomic data, at the top of which is continued deterioration in the job market."
The euro surged to a session high of $1.5700, extending an overnight rally that was sparked by a jump in euro zone inflation to a record high in July. It last traded at $1.5656, up 0.5 percent on the day.
The dollar fell 0.3 percent to 107.75 yen, pushing away from a high of 108.38 yen touched in overnight trade.
The number of U.S. workers filing initial claims for unemployment rose to 448,000 in the week ended July 26 from a revised 404,000 the prior week, the Labor Department said. It was the highest reading since April 2003.
Analysts polled by Reuters had forecast 395,000 new claims.
Separately, data showed the U.S. economy expanded at a 1.9 percent annual rate in the second quarter, up from a revised 0.9 percent in the first quarter and below market expectations for a 2.0 percent growth. That followed a 0.2 percent contraction in GDP during the final quarter of 2007.
"I think the most troubling thing out of all the numbers this morning is the claims number. If that doesn't convince people we're in a recession, then nothing will," said Robert Macintosh, chief economist at Eaton Vance Management in Boston.
The dollar got some respite from a report showing that business activity in the U.S. Midwest rose unexpectedly in July, snapping a five-month run of contraction.
Apart from the record jump in euro zone inflation, the euro also got support from European Central Bank Bank members Nout Wellink and Guy Quaden, who both stressed the need to manage inflation expectations.
Euro zone central bank officials told Reuters the ECB would raise interest rates again despite faltering economic growth if inflation continued to climb or expectations pick up.
Elsewhere, data showing British houses prices crumbled at record rates and consumer confidence hit historic lows in July weighed on sterling, pushing it down 0.1 percent at 78.74 pence.
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