The Australian dollar closed lower after higher-than-expected inflation data increased the chances of a February rate rise.
At 5pm eastern daylight time, the Australian dollar was trading at 90.06 US cents, down from Monday's close of 90.64 cents.
The local unit traded between 89.82 US cents and 90.46 cents during the local session yesterday.
Commonwealth Bank economist Sara Hoenig said the Australian dollar made up for Monday's losses after the release of higher-than-expected inflation data on Wednesday.
"The figures revealed that inflation pressures in Q4 had been mildly firmer than the market had expected with the core inflation measures remaining well above three per cent," Ms Hoenig said.
"This encouraged the market to price in greater expectations for the Reserve Bank to raise rates in February and that supported the Aussie dollar following the release of those figures."
Australia's headline consumer price index (CPI) rose 0.5 per cent in the December quarter, for an annual rate of 2.1 per cent, the Australian Bureau of Statistics said during the domestic session.
The median market forecast was for the headline CPI to rise by 0.4 per cent in the quarter, for an annual pace of 2.0 per cent.
The underlying rate of inflation, according to the average of the ABS trimmed mean and weighted median measures, rose 0.65 per cent in the quarter and 3.4 per cent over the year.
That compared to expectations for 0.6 per cent quarterly rise and a 3.35 per cent annual rate.
Most economists expect the RBA to raise the cash rate by 25 basis points, or quarter of one per cent, to four per cent next week.
Ms Hoenig said the CPI release was the key driver for the day.
Markets are now pricing in a 73 per cent chance of a February rate rise, up from 61 per cent before the inflation data was released on Wednesday.
At 1700 AEDT, the Australian dollar was trading at 80.36 Japanese yen, down from Monday's close of 81.63 yen, and at 64.03 euro cents, up from 63.98 euro cents.
The euro finished at 1.4067 US dollars, down from Monday's close of 1.4162 US dollars, and 125.51 Japanese yen, down from 127.59 yen.
The US dollar was at 89.23 Japanese yen, down from 90.09 yen on Friday.
Meanwhile the Australian share market closed sharply in the red after a broad-based sell-off sparked by concerns about economic worries in China and the United States.
The benchmark S&P/ASX200 index closed down 73.3 points, or 1.55 per cent, at 4,644.6 points, while the broader All Ordinaries index fell 73.1 points, or 1.54 per cent, to 4,670 points.
On the Sydney Futures Exchange the March share price index contract was 63 points lower at 4,591 on a volume of 40,634 contracts.
CMC Markets analyst David Taylor said the sell-off came as investors began to focus on world events.
"We are continually being weighed down by a negative mood in the US with the impending regulatory changes that may be imposed by the Obama administration, and of course China's ongoing monetary policy issues," Mr Taylor said.
"We are not really seeing any panic selling as such, it is more like the market is nauseous but hasn't vomited yet," he said.
Mr Taylor said Standard & Poor's decision to put a negative outlook on Japan's sovereign debt rating also weighed on the market.
Mining giant Rio Tinto ended the day down $3.44, or 4.69 per cent, at $69.90 while rival BHP Billiton fell 95 cents, or 2.3 per cent, to $40.30.
European regulators have formally opened a probe into a proposal by BHP Billiton and Rio to combine their iron ore operations in Western Australia's Pilbara region.
Fortescue Metals fell sharply by 25 cents, or 5.22 per cent, to $4.54.
The gold miners fared badly after the price of the precious metal fell.
At the local close the spot price of gold was $US1,097.11 per fine ounce, down $US4.68 on Monday's closing price of $US1,101.79.
Earlier the Australian dollar opened almost a cent lower today amid fears China is clamping down on its banking sector and reigning in the pace of growth.
At 0700 Australian Eastern Standard Time, the Australian dollar was trading at $US0.9004/06, down from Monday's close of $US0.9059/64.
It was the Australian currency's lowest start to a domestic session since January 4.
Between 1700 AEDT on Monday and 0700 AEDT on Wednesday, the local unit traded between $US0.8938 and $US0.9093.
Domestic markets were closed on Tuesday for the Australia Day public holiday.
The Australian dollar's weak local open followed fresh evidence the Chinese government ordered several banks to stop issuing new loans this month, Bank of new Zealand currency strategist Danica Hampton said.
The move sparked a fresh bout of risk aversion as investors sought "safer" currencies like the US dollar and the yen, she said.
"That really just set the cat amongst the pigeons," she said.
"People worry that a slow down in Chinese growth might de-rail the recovery, so as a result we saw investors ditch growth currencies like the Aussie."
Credit Suisse said in a research note that six unnamed banks had confirmed new lending had been suspended from January 19 after an emergency meeting by the central bank's monetary policy bureau.
The move comes amid growing concerns in Beijing that speculators are taking advantage of the money sloshing around the markets, which could cause stock or property bubbles.
Ms Hampton said the domestic currency had stabilised over the past few hours as investors anticipate Australia's latest consumer price index figures, due from the Australian Bureau of Statistics at 1130 AEDT.
The median market forecast is for prices to have risen by 0.4 per cent in the December quarter of 2009, for an annual rate of 2.0 per cent.
The key inflation data is the focus of the Reserve Bank of Australia's monetary policy.
Most economists tip the central bank to raise the cash rate by 25 basis points to four per cent when the board meets on February 2.
Ms Hampton said the Australian dollar could move higher if the data points to further tightening of interest rates.
"It's really being watched for clues to what the RBA is going to do next week," she said.
"We'll see a stronger currency reaction to a strong CPI rather than a week CPI."
"We could see the Aussie squeeze back to that $US0.9100 level."
