The session was volatile, with the rupee rising as much as 54.18, its strongest against the dollar since May 17, after a media report suggested that the government may remove the withholding of tax on bonds for foreign investors.
However, the rupee gave up the gains as traders said any removal of such a tax remained speculative.
The rupee had rallied more than 5 per cent over the previous four days on improved investor sentiment and hopes of fresh economic reforms after Prime Minister Manmohan Singh took charge of the finance ministry.
"The euro weakened ahead of the Spain debt auction and also the market is expecting an ECB rate cut tomorrow (on Thursday). Oil companies were also seen buying the dollar," said Pramod Patil, a forex dealer with United Overseas Bank, referring to oil companies.
The partially convertible rupee closed at 54.48/49 per dollar as per the SBI closing rate, down 0.2 per cent from its close of 54.36/37 on Tuesday. The rupee moved in a wide band of 54.18 to 54.86 during the session.
Investors are eyeing global risk events, including a sale of Spanish debt later in the day, the ECB meeting of Thursday and the US monthly jobs report on Friday.
The euro slipped against the dollar and the yen on expectations the ECB is about to cut interest rates, which could likely keep the single currency under pressure.
Traders also said HSBC was spotted buying dollars in the domestic markets, likely to remit the funds from its stake sale in private lenders, Axis Bank and Yes Bank late last month.
Some traders said there was major dollar demand from a large state-run bank as well, though no details for the demand were available.
Traders will now await results of the auction for foreign investor limits in government debt. The government last week hiked the limit by $5 billion to $20 billion and the increased limit is being auctioned by the stock market regulator.
The one-month offshore non-deliverable forward contracts were quoted at 54.72 while the three-month were at 55.45.
In the currency futures market, the most traded near-month dollar-rupee contract on the National Stock Exchange, the United Stock Exchange and the MCX-SX all ended at 54.80. The total volume was at $6 billion.
Copyright: Thomson Reuters 2012