The rupee snapped a five-day losing streak on Wednesday as dollar sales by a power sector financing firm helped offset demand from oil and gold importers while positive domestic shares also aided.
Traders said gold importers were spotted buying the greenback to pay for their purchases, especially since the yellow metal remained within sight of almost four-month lows in the global market.
Gold prices in India extended losses to their lowest in nearly two weeks on the back of a stronger rupee, which prompted some bargain buying by importers in the wedding season.
"Defence demand has been on the higher side these days along with the normal oil demand. But there were some inflows heard from a power sector financer," said A. Ajith Kumar, a foreign exchange dealer with Federal Bank.
"Think the rupee may now consolidate between 54 and 55 levels for some time," he added.
Other traders also attributed the dollar inflows of around $300 million to Power Finance Corp. PFC was likely to raise $500 million via mid-term notes this week at the earliest, chairman Satnam Singh had said last week.
The partially convertible rupee closed at 54.55/56 per dollar versus its previous close of 54.85/86. The unit moved in a range of 54.4850 to 54.93 during the session.
Traders said gains in the euro and other Asian peers also supported sentiment for the rupee.
The euro hit a 16-month high against the yen and 7-1/2 month peak against the dollar on Wednesday, helped by better-than-expected German business confidence data.
The BSE Sensex rose for a second consecutive session, marking its highest close in almost two weeks, led by IT stocks such as Infosys after recent losses were seen as overdone with hopes of a resolution to the "U.S. cliff" standoff also likely to improve the outlook for the sector.
"The sentiment was broadly positive rupee today but there was the usual oil and defence demand in early trade. Gold demand was also strong today. Rupee is unlikely to strengthen much from here though, as month and year-end demand will again push it lower," the treasurer at a large state-run bank said.
In the offshore non-deliverable forwards market, the one-month contract was at 54.91 while the three-month was at 55.43.
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 54.72 with a total traded volume of around $4.65 billion.