The prospect of a wobble on the credit markets is disturbing many

The euro rose to a new peak of $1.379 against the dollar early on Thursday, before pulling back to $1.3782.

The pound, already at 26-year highs against the greenback, touched $2.0344, before easing to $2.0297.

Confidence in the dollar has fallen away as the crisis in the US sub-prime lending sector risks wider volatility and retrenchment in credit markets.

Credit crunch?

It is feared that banks and other firms with exposure to the riskier US sub-prime mortgage market - which is suffering a wave of repossessions - may scale back investments elsewhere.

Weakness in the housing market has weighed on the dollar with expectations that problems could spread to the wider economy and lead the Federal Reserve to cut interest rates.

As long as the market is biased toward a Fed cut rather than a hike, the trends stay in place

Derek Halpenny, BTM-UFJ

This comes at a time when rates are rising in most other industrialised economies.

The European Central Bank has been raising rates steadily this year while the Bank of England raised rates for the fifth time in a year earlier this month.

The Bank of Japan opted to keep rates on hold on Thursday, leading the yen to rise temporarily against the dollar, but experts still expect rates to rise again soon.

"As long as the market is biased toward a Fed cut rather than a hike and the European Central Bank and others are raising rates, the trends stays in place," said Derek Halpenny, senior currency strategist at BTM-UFJ.

Political row

The weak dollar is good news for Europeans travelling to the US this summer. In contrast, US visitors to the UK and Europe will find life more expensive.

European firms exporting goods to the US may lose competitiveness in the market there, but the cost of raw materials and oil, priced in dollars, will come down.

The currency equation is good for British visitors to the US

The robust euro has become a political issue in recent days with French President Nicolas Sarkozy criticising its impact on French businesses and calling for eurozone members to have more influence over rate-setting policy.

This led to a rebuke from German Chancellor Angela Merkel who said the European Central Bank's independence was sacrosanct, describing it in an interview with German television as "the alpha and omega" of the organisation's existence.

"The competitiveness of European economies is decided not on the currency markets but by their capacity for restructuring and innovation," German finance minister Peer Steinbrueck added on Thursday.