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 The Indian rupee weakened on Thursday to reverse most of previous day's gains owing to dollar demand from importers and banks, while investors braced for a key U.S. inflation report.

The partially convertible rupee fell up to 81.9150 at one point, before settling at 81.8075, versus its previous close of 81.4350.

The currency had risen for a third straight day on Wednesday, with gains of 0.6% as inflows improved amid positive risk sentiment.

Traders cited dollar demand by foreign banks at the daily Reserve Bank of India fixing rate, as well as by oil companies for Thursday's drop.

"Yesterday's move...seemed excessive and therefore a correction looked imminent", said Anil Bhansali, head of treasury at Finrex Treasury. Bhansali expects rupee to trade in the range of 81.50 to 83.00 per dollar in the coming days.

USD/INR forward premiums declined with the 1-year implied yield falling two basis points to 2.31%. Traders said banks did buy/sell swaps ahead of the U.S. inflation data.

Meanwhile, the dollar index crept higher by late afternoon heading into October inflation data, which the U.S. Federal Reserve considers crucial to determine its monetary policy.

"Today's CPI data will not be the final say on that decision, but it can set the tone regarding the Fed's comfort level," analysts at ING said.

"Any upside surprise could do some damage to the recent benign risk environment and end the recent correction in the dollar."

The greenback has gone from trading near 113 last week to 110.75 currently. On the day, Asian currencies and stocks declined, with Indian shares shedding 0.7%.

However, a downturn in oil prices is expected to support the rupee a bit, with Brent crude futures down 6% so far this week on concerns about China demand falling short.