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The dollar rallied on Thursday after falling the previous day as central banks continued to roil currency markets, while sterling hit a three-week low ahead of a finely poised Bank of England decision.

The dollar index, which tracks the currency against six peers, was up 0.29% at 104.35. It fell 0.4% the previous day after the Federal Reserve held rates steady but opened the door to reducing borrowing costs in September.

Chris Turner, head of global markets at ING, said geopolitical tensions and a slowing global economy were likely supporting the dollar, a traditional "safe haven" for investors at moments of stress, even with the Fed heading for rate cuts.

"The geopolitical and the macro environment elsewhere in the world isn't actually great," he said. "Obviously we've still got some real tensions in the Middle East, and the manufacturing sector is seemingly in recession across large parts of Europe and in Asia."

Hamas leader Ismail Haniyeh was assassinated in Tehran on Wednesday, an attack that drew threats of revenge against Israel and fuelled fears of a wider Middle East war.

The euro fell to a three-week low at $1.0782 and was last down 0.36% as the dollar picked up.

Investors' positioning ahead of a possible BoE rate cut later in the day was knocking the pound, spilling over to other currencies and supporting the dollar, said Lee Hardman, currency strategist at MUFG.

Japan's yen was roughly flat, with the dollar at 149.87 yen.

The yen jumped around 1.8% the previous day after the BOJ raised rates for a second time this year. It rallied 7.3% in July, its strongest monthly performance since November 2022, after starting the month rooted near 38-year lows.

Intervention by Japanese authorities to boost the currency kicked off the move higher, combining with a narrowing of the U.S.-Japan interest rate gap to trigger an unwind of profitable carry trades, in which traders borrow the yen at low rates to invest in dollar-priced assets for higher returns.

STERLING SLIDES VERSUS DOLLAR

The pound dropped 0.57% to a three-week low of $1.2779 ahead of a knife-edge interest rate decision by the Bank of England at 1100 GMT.

Traders think there is a roughly 62% chance the BoE lowers rates from a 16-year high of 5.25%, according to pricing in derivatives markets, similar to Wednesday and up from around 58% at the start of the week.

Sterling has fallen from a one-year high above $1.30 in mid-July as investors' views on BoE rate cuts have shifted.

Fed Chair Jerome Powell on Wednesday stressed that the central bank was also focused on keeping the labour market healthy, adding new emphasis to Friday's U.S. jobs report for July.

It is expected to show that employers added 175,000 jobs during the month, a step down from 206,000 in June. Data on weekly jobless claims is due later on Thursday.

Traders are now anticipating 72 bps of easing this year. The Fed meeting "has bolstered market expectations that bigger rate cuts remain likely, and will be heavily influenced by how the economy progresses from here", said Charu Chanana, head of currency strategy at Saxo.

In other currencies, the Australian dollar was 0.28% lower at $0.6518 after sliding 2% in July as it got caught up in the unwinding of carry trades.