By Vikram Subhedar
LONDON (Reuters) - The dollar extended its recovery against a basket of other currencies on Friday, while banks dragged European shares slightly lower following underwhelming results from Swiss major UBS.
The two-day recovery comes after the dollar suffered a 4 percent drop in the three weeks from Jan. 3 reflecting doubts about how U.S. President Donald Trump's policies will play out for the currency, particularly after both Trump and Treasury Secretary-designate Steven Mnuchin hinted at concerns over its strength.
The dollar index which measures its strength against a basket of six major currencies rose 0.2 percent to 100.54.
Trump suggested overnight he would push ahead with a 20 percent border tax on Mexico, spurring a slump on the peso and refocusing market expectations on his pro-business policies which, along with healthy corporate results, helped stocks on Wall Street to fresh record highs.
Some U.S. protectionism is seen as dollar-positive as it may bring capital home.
"The (dollar) has experienced a powerful rebound re-establishing post-U.S. election relationships between the performance of risk assets and U.S. bond yields on the one hand and the (dollar) on the other hand," said Morgan Stanley (NYSE:MS) FX strategists led by Hans Redekker, in a note to clients.
Benchmark German bonds are headed for their worst week since the aftermath of November's U.S. election on Friday, as Trump's first week in office fuels expectations of inflation and growth-boosting policies in the world's biggest economy.
Investor flows continue to point to a preference for so-called "reflation" trades, according to the latest weekly data from Bank of America-Merrill Lynch and fund tracker EPFR.
Funds investing in TIPS, which offer protection against rising inflation, high-yield bonds and Japanese equities, attracted inflows over the past week, the data showed.
"But the re-positioning feels grudging and flows have yet to show big asset allocation capitulation out of bonds into stocks," Bank of America-Merrill Lynch strategists said.
European stocks were headed for a weekly gain of about 1 percent though were slightly lower on Friday as weakness in the banking shares weighed.
A fall in profits sent UBS shares down more than 3 percent as investors locked in some gains following a strong rally in financials stocks following the U.S. election. The European banking index fell 1.2 percent.
In the UK, the FTSE was also slightly lower but outperformed other regional benchmarks supported by merger activity as leading supermarket operator Tesco (LON:TSCO) snapped a smaller wholesaler. Tesco shares surged 10 percent.
In commodity markets, oil prices gave up earlier gains as rising crude output from the United States was seen offsetting efforts by OPEC and other producers to prop up the market by cutting supplies.
Trading was choppy however as volumes were lighter than average with much of Asia closed due to the start of the Lunar New Year holiday.
Brent crude futures, the international benchmark for oil prices, were trading at $55.98 per barrel, down 0.5 percent from their last close.
U.S. West Texas Intermediate (WTI) crude futures were down 0.2 percent at $53.67 a barrel.