The 0.5% increase in retail sales reported Thursday by the Commerce Department was smaller than expected. Economists surveyed by Dow Jones Newswires forecast a 0.6% increase.

Several categories of retailers tumbled last month. The increases tended to be among sellers of essential items, such as food and clothes.

Filling station sales rose 3.6%. Excluding gasoline sales, other retailers’ sales increased 0.2%. Gas prices have gone up about 28% in the past six weeks, driving station receipts.

Overall retail sales in April were revised higher, decreasing 0.2% instead of 0.4% as previously reported. March sales fell 1.2% instead of 1.3%.

Higher stocks encourage position taking out of the dollar, a major funding currency. The Dow Jones Industrial Average was recently up about 28 points on the day.

The euro had already recovered earlier from a one-week low against the U.S. unit, $1.4070, after the market got past the day’s key economic events.

It was sold off on a broad rebound in the buck from a 2009 low, as traders took profits on the recent rally in riskier assets and with a return of some caution. A sharp dip also came on rumors, since denied, that U.K. Prime Minister Gordon Brown would resign.

However, overall, currencies are trading inside a very narrow range ahead of the much awaited May U.S. payrolls report to be released Friday.

Thursday afternoon in New York, the euro was at $1.4174 from $1.4145 late Wednesday. The dollar was at Y96.48 from Y95.97, according to EBS. The euro was at Y136.75 from Y135.73, and the U.K. pound was at $1.6136 from $1.6283. The dollar was at CHF1.0692 from CHF1.0715 Wednesday.

Mixed signals in remarks by European Central Bank President Jean Claude Trichet, after the bank left interest rates unchanged at 1.0%, had little impact on the common currency.

Trichet stressed that euro zone policy makers are already thinking about exit strategies from easing mode. He also said that the ECB isn’t considering expanding its EUR60 billion covered bond purchase program, or any other non-standard easing measures.

This helped to boost the euro against the U.S. unit, as the Federal Reserve is seen as possibly expanding its Treasury purchases.

However, Trichet was very cautious on the euro zone’s growth outlook. He also spoke on the importance of a strong dollar policy in the U.S. in response to a question on the euro’s three-month rally.

The Bank of England also voted to keep rates unchanged Thursday, as expected.

Elsewhere, emerging markets in Europe were shaky Thursday. Assets continued to feel the fallout from Latvia’s escalating financial crisis, particularly the Hungarian forint and Polish zloty.

Signs that Latvia’s economic woes are worsening have prompted speculation that authorities could be preparing to drop their currency’s peg to the euro, despite repeated official denials.

The Latvian central bank Thursday said it will maintain the stability of the national currency until the euro can be adopted.

A European Commission spokesman said earlier Thursday that European Union and International Monetary Fund officials are currently in Latvia “assessing the situation.”

Bank-lending rates in Latvia rose to record highs Thursday, a new sign of a growing liquidity shortage.

Swedish banks, which are heavily exposed in the Baltic region, saw their stock prices recover heavy losses Thursday after the Swedish government pledged support to any Swedish banks running into trouble. But the Swedish krona remains near the low end of its recent trading ranges against the dollar and euro after falling sharply Wednesday.

“There wasn’t much of an activity in the (currency) market. People are waiting on the sidelines to see what the U.S. numbers say,” said a trader with a foreign bank.

The trader said that if the data for May show signs of improvement, appetite for regional currencies will increase as it will be a sign that the global economy is recovering.

Another trader with a local bank said that even though the local currency was lower, it was well bid as the regional equities markets remained in positive territory most of the day.

Local government bonds were mixed, with players selling longer-dated maturities in favor of short-term bonds.

“Also, with equities market being healthy, there was a bit of selling in the bonds,” a trader with a local bank said.

The leveraged loan market has staged a strong rally as consensus that a recovery is just around the corner becomes more entrenched, prompting investors to look further and further down the ratings spectrum in a bid to boost returns.

Loans rated triple-C recorded an 18.31% gain in May to return 43% so far this quarter, according to the S&P/LSTA Leveraged Loan Index. That’s the best month ever, according to Standard & Poor’s LCD unit and well ahead of loans from borrowers rated single and double B. Single- and double-B rated loans gained 7.4% and 2.93% last month, respectively, with returns of 20% and 9.5% so far this quarter. This is in stark contrast to the first three months of the year when BB-rated loans returned 13.5% and loans from triple-C-rated borrowers returned a negative 7.6%.

“In June 2007, leveraged loans were priced as though no loan would default, but at the end of last year they were priced as though every one would default. Now some normalcy has returned,” said Steven Miller, managing director of S&P’s LCD. With the S&P/LSTA index returning 26.63% year-to-date, leveraged loans have outperformed most other asset classes this year. But they might not have rallied so furiously without the help of the junk bond market, which has
returned with a vengeance.

More and more junk-rated borrowers have been turning to the bond market this year to refinance billions of dollars of leveraged loans maturing through 2014.

Issuance of junk bonds has soared even as the market prepared itself for Monday’s chapter 11 bankruptcy filing from General Motors Corp. This has helped cut the stock of leveraged loans and put money back into the market, giving loan investors a stream of cash to put to work.

Indeed, proceeds from about 60% of high-yield bond sales in 2009 have been used to pay down bank debt and this has already helped reduce the amount of outstanding loans to $575 billion, according to Miller.

“If the high-yield market remains strong, the loan market has further to run and it can get back to business,” Miller said. “We can get to a more normal situation where the loan market is printing $200 billion a year in new issuance…” he said.

The rising prices and the prospect of excellent returns will continue to lure investors and may even encourage managers of collateralized loan obligations, structured product that pool high-risk loans sold by junk-rated companies, to return.

But for that to happen, investors have to keep believing that the banking system will heal and that the economy will improve. “…and these things have to continue to be true for the loan market to continue its rally,” Miller said.