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The euro grazed a three-week low on Thursday, driven by mounting expectations that the European Central Bank (ECB) may cut rates as early as March, while the prospect of a shift in Japanese policy gave the yen its biggest one-day boost since January.

The euro is heading for its biggest weekly fall since May, fuelled by a dramatic repricing of interest rate expectations for 2024, although caution around Friday's U.S. non-farm payrolls has kept trading volatility subdued.

Falling inflation, a slowdown in major economies such as Germany and softness in the labour market have prompted traders to assume rates will fall to 3.0%, from 4% currently, by September, from an expectation of 3.4% just two weeks ago.

As a result, the euro has hit eight-year lows against the Swiss franc and three-month lows against the pound this week.

"The speed of the dovish repricing for the euro zone has been more aggressive than it has been for the Fed and the other G10 central banks. But big difference is there is enough in the data still for the Fed to push back," TraderX strategist Michael Brown said.

"What can the ECB point to that justifies them pushing back on the rapid pace of easing next year?" he said.

The ECB meets next Thursday for its final meeting of 2023. There has been very little resistance from policymakers to the recent repricing of rates, with even known hawk Isabel Schnabel taking rate hikes off the table.

The question of a rate cut could emerge in 2024, ECB member and Bank of France head Francois Villeroy de Galhau told a French paper in an interview published on Wednesday.

Villeroy said that "disinflation is happening more quickly than we thought".

The euro, which has fallen 0.95% this week, was up 0.15% at $1.07795. Against the Swiss franc, it was steady at 0.9422 francs, above an overnight low of 0.9415, its weakest since early 2015, when the Swiss National Bank removed its peg between the two currencies.

YEN OUTPERFORMS

Meanwhile, the yen was the clear outperformer on Thursday, rising more than 1% to its strongest against the dollar in three months.

The Bank of Japan has been the lone holdout among central banks, by maintaining a policy of ultra-low rates that sent the yen to its weakest in decades against the dollar and sparked speculation that monetary authorities could intervene to prop up the currency.

Expectations are growing for the BOJ to signal it will soon wind down this policy and next week's meeting may provide that opportunity.

BOJ Governor Kazuo Ueda said on Thursday the central bank has several options on which interest rates to target once it pulls short-term borrowing costs out of negative territory.

Markets took this as a potential sign that change may be imminent and pushed the yen, which has been punished by speculators taking large bearish positions, higher.

The dollar was last down 1.3% against the yen at 145.325.

"It probably speaks to the positioning that we’ve seen. The market is very, very heavily short the yen and we’ve got a heavy consensus in for 2024 that this is going to be the year that they bring negative rates to an end. So it shows the market is ready to latch on absolutely anything that it can in light of that," TraderX's Brown said.

The dollar index, which shed 3% last month, was down 0.3% at 103.87, not far off a two-week high, with Friday's payrolls the main focus.

Separate U.S. jobs data this week has suggested the labour market is softening, but not showing any material weakness. Futures markets are pricing in a 60% chance of a rate cut by March, up from 50% a week ago, according to the CME's FedWatch tool. But analysts think this might be overdone.

The Canadian dollar was steady against the U.S. dollar at 1.3587 per dollar after the Bank of Canada on Wednesday held its key overnight rate at 5% and, in contrast to other central banks recently, did not rule out another hike.