The rupee fell to its lowest in over a week on Friday after heavy dollar buying by a large state-run bank wiped out all gains even as a below expected inflation reading raised hopes that the central bank could start cutting interest rates as early as January.
The dollar buying by the large-bank was likely related to government defence purchases, several dealers said.
Earlier, data showed that wholesale price based inflation eased, leading to gains in the equity market, and in the rupee on hopes that along with the strong factory data, it would bolster the case for the RBI to ease policy.
India's wholesale price index rose a slower-than-expected 7.24 percent in November, less than the 7.6 percent estimated by a Reuters poll.
While most economists and market participants believe the central bank may hold rates steady on December 18., some are now expecting that it will infuse some liquidity in the form of a cash reserve ratio cut.
"The trending and expectation in headline inflation has improved, paving way for start of rate cut cycle in January-March 2013," said Moses Harding, head of asset liability management at IndusInd Bank.
"A CRR cut of 25 basis points is seen certain to maintain the positive feel," he said.
The government is trying to push through more reforms, approving steps on Thursday to speed up infrastructure projects and facilitate investment into the fertiliser sector.
The Sensex, which was trading flat before the data release, ended 0.46 percent higher.
The partially convertible rupee ended at 54.4850/4950 per dollar, marginally weaker than its Thursday close of 54.46/47. It fell to 54.70 in the session, its lowest level since December 4.
In the offshore non-deliverable forwards, the one-month contract was at 54.74, while the three-month was at 55.26.
In the currency futures market, the most-traded near-month dollar/rupee contracts on the National Stock Exchange, the MCX-SX and the United Stock Exchange all closed at around 54.58, with total traded volume of $6.4 billion.