The US dollar fell sharply on Tuesday, hitting a 10-week low against the euro, in spite of the absence of any overwhelming catalyst for the sell-off. The euro hit a record high against the yen.

Two major explanations were advanced for the dollar’s initial slide. One was a return of fears that Asian and Middle Eastern central banks may be about to diversify their reserves out of the dollar, re-opening the debate over the funding of the vast US current account deficit.

Cheng Siwei, a vice-chief of China’s National People’s Congress, started the ball rolling, saying: “China can stop buying dollar-denominated bonds, increase buying of US products and gradually reduce its holdings of US bonds.”

The People’s Bank said Mr Cheng’s views were purely his own, while analysts pointed out that he had no involvement in economic or financial policy.

“He is a parliamentarian rather than a key economic decision maker,” said Steven Saywell, chief currencies strategist at Citigroup.

However, just hours later, Kuwait and Qatar joined the United Arab Emirates in suggesting that they might buy more euros, at the expense of the dollar.

Mr Saywell played this down, pointing out that the largest reserve-holder of the trio, the UAE, held just $23.4bn.

Mansoor Mohi-uddin, chief FX strategist at UBS, half agreed, saying: “There is nothing very new or alarming about any of these comments, but heightened market attention to this theme shows the extent to which the structural concerns which plagued the dollar in 2003 and 2004 are back in play.”

Hans Redeker, head of currency strategy at BNP Paribas, argued that the comments were indicative of how the region’s private investors and government-run investment funds, which together carry much more clout, may act in the future.

The other explanation doing the rounds yesterday was based on mounting expectations that US and eurozone interest rate differentials will narrow this year.

An unexpected fall in the eurozone unemployment rate to 8.2 per cent, allied to a jump in producer prices, fuelled fresh talk that the European Central Bank will raise rates in May, a likely precursor to further tightening later in the year.

In contrast, a run of softer data in the US has fed expectations that the Federal Reserve will call it a day after taking rates to 5 per cent in May.

There was agreement that the initial move was accelerated by the triggering of a swathe of stop orders. Volatility in euro/dollar had fallen to multi-year lows as the pair had traded in a narrow range for several months, leaving the market prone to a sharp move.

“The accumulation of positions in a very tight band left the market vulnerable to a surprise,” said Tony Norfield, global head of FX strategy at ABN Amro.

Chris Towner, consultant at risk manager HIFX, said: “The move came when traders looked at each other and said ‘it’s about time we broke out of these ranges’, and took out the stops.”

The result was that the dollar fell 1 per cent to $1.2254 to the euro, 0.2 per cent to Y117.47 against the yen, 0.9 per cent to $1.7551 against sterling, 1.1 per cent to SFr1.2905 against the Swiss franc and 0.5 per cent to C$1.1654 versus the Canadian dollar.

The euro’s role as the obvious currency to rotate into saw it rise 0.8 per cent to a lifetime high of Y143.95 against the yen.

Elsewhere, the South African rand rose 1.1 per cent to R6.0114 to the dollar on continued feedthrough from buoyant gold prices and the possibility of a Moody’s upgrade thanks to record foreign exchange reserves.

The Thai baht rose 0.8 per cent to a 12-month high of Bt38.5 to the dollar as Thaksin Shinawatra, the prime minister, said he would step down to end a long running political crisis.