A 6 per cent drop in Chinese stocks on Tuesday drove currency investors into safe-haven currencies such as the yen and the Swiss franc, albeit in thin volumes.
The British pound, though, was an outperformer, boosted by better-than-expected inflation data for July, including an uptick in core inflation, which hit a five-month high.
That bolstered expectations that the Bank of England will raise interest rates in coming months and helped sterling gain 0.6 per cent against the dollar and the euro.
Earlier, China’s main Shanghai Composite and Shenzhen 300 indices both lost more than 6 per cent as investors bet that demand in China will cool further, weighing on the trade-reliant region and throwing more doubts on a global recovery.
The dollar fell 0.1 per cent against the yen to trade at 124.30 yen while against the Swiss franc it was down 0.3 per cent at 0.9760 francs. The euro was also down 0.3 per cent against the franc at 1.0805 francs.
"There is a risk-off environment, given the drop in the Chinese stock markets. Investors are cautious about whether the Fed will raise rates, given a slowdown in China and global deflationary conditions. All these are weighing on the dollar," said Petr Krpata, FX strategist at ING.
Against a basket of major currencies, the dollar was flat on the day, trading at 96.798, having started the day on a firm note. It was still holding above a one-month low of 95.926, set last week when Beijing's surprise devaluation dented expectations that the Fed will raise rates in September.
China’s central bank has since tempered the yuan’s slide, soothing anxiety of a further sharp devaluation - a scenario that markets feared could lead to a global currency war.
However, the latest slide in Chinese stocks has reignited fears that Beijing may still be intent on a deeper devaluation.
Many still expect the Fed to move in September, though much depends on the robustness of US data and global stock markets in the coming weeks.
“As long as China doesn’t continue to aggressively devalue the yuan, we will see it (a rate hike) in the next six months, and the US dollar will be stronger,’’ said Jeffrey Halley, FX trader for Saxo Capital Markets in Singapore.