TOKYO: The yen was under pressure on Tuesday on speculation that the Bank of Japan might loosen policy while increased risk appetite after the Federal Reserve's easing last week helped keep the dollar near a seven-month low against a basket of currencies.
That left the euro close to four-month highs both against the yen and the dollar, though some traders think the single currency's rally since late July may be running out of steam soon.
The dollar traded at 78.57 yen, after having risen as high as 78.93 yen on Monday, way above a seven-month low of 77.13 yen hit just last Thursday, driven by buying by speculative accounts such as hedge funds, traders said.
"There's quite a lot of expectations about the BoJ's easing priced in now. The dollar/yen is unlikely to fall much ahead of the outcome of the BOJ's policy meeting," said a senior trader at a European bank, referring to the bank's two-day meeting starting on Tuesday.
The Federal Reserve's announcement last week of a new asset-buying programme has spurred speculation that the Bank of Japan might look into policy easing to counter the effect of the US stimulus.
Also supporting the dollar versus the yen was a rise in US bond yields after the Fed's action. The 10-year US bond yield stood near a four-month high of 1.89 percent hit on Friday.
The dollar/yen has traditionally had a high correlation with US bond yields, partly based on the perception that higher US yields should attract more dollar-buying by Japanese investors.
"The Fed's QE3 had been considered as the possible biggest reason to push the dollar against the yen. But now with US bond yields rising on expectations the QE3 will boost the economy, buying in the yen has lost momentum," said Yunosuke Ikeda, senior FX analyst at Nomura Securities.
Bond prices fell and yields rose after the Fed's QE3 move on expectations of higher growth and possible inflation. Prices rebounded and yields gave up gains on Monday after the sharp moves of late last week.
The yen also might be undermined slightly by concerns about anti-Japan protests in China, Japan's biggest trading partner, over a territorial dispute.
Its impact could grow if Chinese boycotts of Japanese products become large enough to dent Tokyo's exports to China and worsen Japan's trade balance, traders said.
For now, the dollar/yen is capped at the bottom of the cloud at 78.72 on the daily Ichimoku chart, though a break there could open the way for a test of the Aug. 20 high of 79.66 yen, some market participants said.
The euro stood at 102.96 yen, having rallied to a four-month high of 103.858 yen on Monday.
ON STEROIDS
Against the dollar, the euro fetched $1.3103, down slightly from late US levels but still not far from a 4 1/2-month high of $1.3173 hit on Monday.
The euro has rallied some 9 percent from a two-year low of $1.2040 in July when investors were deeply worried that the currency bloc might be heading for a break-up as Spanish and Italian borrowing costs were soaring.
For now, the euro is supported by optimism that the European Central Bank's new bond buying programme could help Madrid survive its debt crisis, though some are concerned that Spanish bond yields have risen over the past few days.
Increased risk appetite after the Fed promised to pump $40 billion a month into the economy is also helping the euro and other growth-linked currencies.
"Markets are now having steroids. Everyone knows the steroids will lose their power at some point in the future. But for the moment, they are working," said a trader at a US bank.
The euro's rise saw the dollar's index against a basket of currencies hovering near seven-month low.
The dollar index stood at 78.95, near a seven-month low of 78.601 hit on Friday.
The Australian dollar traded at $1.0475, off a six-month high of $1.0625 set on Friday, pressured by worries that slower growth in China would put the brakes on Australia's mining boom.
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