The yen also rallied versus the euro and other currencies, further buoyed by a jump in 10-year Japanese government bonds yields, to 1.000 percent, the highest in a year.

China's factory activity shrank for the first time in seven months in May, a survey showed, deepening fears that China's economic recovery has stalled and a sharper cooldown may be imminent.

Concerns that US monetary stimulus could be scaled back, sparked by Federal Reserve Chairman Ben Bernanke's testimony on Wednesday, also weighed on markets and drove Japan's Nikkei share index down 7.3 percent on Thursday, its biggest one-day drop since a slide two years ago in the wake of the tsunami.

"The yen's outperformance Thursday served as a reminder that despite its bearish long-term outlook, it stands to rally when investors turn skittish and need a safer place to hide," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington.

Analysts said the dollar could drop further against the yen if stocks continued to decline. But they expected the trend of yen weakness and dollar strength to remain given aggressive easing in Japan and the prospect of tighter US policy.

"I still think the scope of easing that the government is doing in Japan is going to have an effect and eventually is going to drive dollar/yen higher," said Fabian Eliasson, vice president of currency sales at Mizuho Corporate Bank in New York.

The yen hit a two-week high of 100.82 to the dollar, reversing a slide to a 4-1/2-year low of 103.73 yen on Wednesday after Bernanke told Congress the Fed could "in the next few meetings take a step down" in its bond buying.

The dollar was last at 101.79 yen, down 1.3 percent for the day, the worst daily performance since mid-April. Some $7 billion in yen changed hands on Thursday on Reuters Dealing, the highest daily volume since at least September.

At the session peak, the yen rose more than 2 percent against the dollar and the euro.

The euro slid to a two-week low of 129.94 yen, having touched a 3-1/2-year peak of 133.77 yen on Wednesday. It was last at 131.73 yen, down 0.7 percent.

Against the dollar, the euro zone common currency was up 0.6 percent at $1.2938. The euro got a modest lift from data showing the downturn across euro zone businesses eased slightly this month.

But the numbers in the euro zone PMI business survey pointed to another contraction in the 17-member bloc in the second quarter. Analysts expected the euro to stay weak against the dollar, given concerns that the Fed will taper its asset-purchase program while the European Central Bank could ease monetary policy further.

The Swiss franc, another safe haven that has sold off lately, rallied. The dollar fell 1 percent to 0.9682 franc , while the euro lost 0.4 percent to 1.2528 francs .

Some traders said the market's reaction to Bernanke might be short-lived. They focused on Bernanke's caveats that the Fed would need to see more improvements in the economy before reducing stimulus, although the minutes from its most recent meeting showed some policymakers were willing to cut bond buying as early as June.

James Bullard, president of the Federal Reserve Bank of St. Louis, said on Thursday that he did not think the Fed was "that close" to starting the process of winding down its support although it was the likely next step if the economy continued to improve and inflation picks up.

While major North American equity markets closed lower, most of them finished the day off their session lows as investors saw the early fall from record highs as an opportunity to buy.

The Japanese yen rallied sharply against the US dollar and the euro after a shock drop in Chinese factory data hurt Asian and European stock markets, and the Canadian currency went along for the ride.

"The main story today was the ability of equity markets to get back some of their losses, and that would be consistent with the improvement we saw in some of the riskier currencies, Canada included," said Mark Chandler, head of Canadian fixed income and currency strategy at Royal Bank of Canada.

The Swiss franc, seen as a safe bet in uncertain times, rose as well.

The gains, which brought the Canadian currency back below C$1.03 to the greenback after nearing C$1.04 on Wednesday, could be overshadowed on Friday and early next week as the market looks ahead to a Bank of Canada policy announcement the middle of next week and first-quarter gross domestic product figures next Friday.

"The extent of any gains in the Canadian dollar are going to be somewhat limited, at least until we get over the hump of the (Bank of Canada) meeting," Chandler said.

The loonie, as the Canadian currency is colloquially known, had fallen almost four cents since it neared parity with the greenback in early May.

It ended on Thursday at C$1.0294, or 97.14 US cents, after ending Wednesday's North American session at C$1.0372 to the greenback, or 96.41 US cents.

The loonie gained marginally against the Australian dollar , another commodity currency, but one that is more closely tied to the fortunes of China due to its geographical proximity.

A preliminary survey of manufacturing in May in China, the world's second largest economy, showed it shrank for the first time in seven months.

European factory sentiment dropped, suggesting that the euro zone's economy was likely to contract again in the second quarter.

Meanwhile, comments on Wednesday by US Federal Reserve chairman Ben Bernanke that Fed stimulus measures could be scaled back also added to investor caution worldwide.

"The Canadian dollar is caught in a nasty move in global markets," said Adam Button, currency analyst at ForexLive in Montreal.

He said correlations between asset classes had broken down and investors were struggling to guess where markets go from here.

"It's walking on a razor's edge right now. It's 24 hours of fright, after three months of exuberance," Button said. "It could prove to be a turning point, or a blip. At this point, I lean more toward a turning point, and continued Canadian dollar weakness."

Prices for Canadian government debt were mixed, with the two-year bond down less than a cent to yield 1.036 percent, while the benchmark 10-year bond added 5 Canadian cents to yield 1.964 percent.

China's factory activity shrank for the first time in seven months in May as new orders fell, a preliminary manufacturing survey showed, entrenching fears that its economic recovery has stalled and that a sharper cooldown may be imminent.

Concerns US monetary stimulus could be scaled back, after testimony on Wednesday by Federal Reserve Chairman Ben Bernanke, added to investor caution and drove Japan's Nikkei share index down 7.3 percent, its biggest one-day drop in two years.

"What we saw was a massive sell off in Japanese equities and a pull back in risk with the yen being the biggest beneficiary," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington, D.C., but "a lot of the drivers are still in place and we are likely to see the dollar push higher and the yen push lower."

At the session peak, the yen rose more than 2 percent against the dollar and the euro, which both lost 1 percent against the Swiss franc , also seen as a safe haven.

The yen hit a two-week high of 100.82 to the dollar, reversing a slide to a 4-1/2 year low of 103.73 yen on Wednesday after Bernanke told Congress the Fed could "in the next few meetings take a step down" in its bond buying.

The dollar was last 101.68, down 1.4 percent on the day.

With the dollar up about 17 percent against the yen this year, analysts said the Chinese data and the drop in stocks provided the excuse for a profit-taking correction.

"The market got overextended in terms of bullishness on dollar/yen yesterday after the Bernanke comments. We now have seen a correction and some uncertainty in the JGB (Japanese government bond) markets," said Jeremy Stretch head of currency strategy at CIBC World Markets in London.

"The market was somewhat overbought and this prompted a fairly aggressive reaction (in dollar/yen) which was overlayed by a pretty seismic move in equities as well."

Analysts said the dollar could drop further against the yen if stocks continued to decline. But they expected the trend of yen weakness and dollar strength to remain given aggressive easing in Japan and the prospect of tighter US policy.

"The correction (in dollar/yen) has the potential to go further ... But there is no risk of a dramatic fall and any move below 100 should be brief," said Niels Christensen, currency strategist at Nordea in Copenhagen.

Some traders focused on Bernanke's caveats that the central bank would need to see more improvements in the economy before reducing stimulus, even though Fed minutes showed some policymakers were willing to cut bond buying as early as June.

The euro slid to a two-week low of 129.94 yen, having touched a 3 1/2-year peak of 133.77 yen on Wednesday. It was last at 131.19, down 1.1 percent.

The single currency was up 0.3 percent at $1.2895, helped slightly by data showing the downturn across euro zone businesses eased slightly this month.

But the euro zone PMI business survey numbers pointed to another contraction in the euro zone in the second quarter. Analysts expected the euro to stay weak against the dollar given concerns the Fed will taper its asset-purchase program while the European Central Bank could ease monetary policy further.

A sharp slide in commodity prices hurt the Australian dollar , along with the Chinese data. China is Australia's biggest export market.

The Aussie last traded down 0.1 percent at $0.9686, recovering from $0.9592, its lowest in nearly a year.

The Japanese yen rallied sharply against the US dollar and the euro after a shock drop in Chinese factory data hurt stock markets, while the Canadian went along for the ride.

"The Canadian dollar is caught in a nasty move in global markets," said Adam Button, currency analyst at ForexLive in Montreal.

He said correlations between asset classes had broken down and investors were struggling to guess where markets go from here.

"It's walking on a razor's edge right now. It's 24 hours of fright, after three months of exuberance," said Adam Button, currency analyst at ForexLive in Montreal. "It could prove to be a turning point, or a blip. At this point, I lean more towards a turning point, and continued Canadian dollar weakness."

The loonie, as the Canadian currency is colloquially known, has fallen almost four cents since it neared equal value with the greenback in early May.

By mid-morning it was trading at C$1.0334, or 96.77 US cents, after ending Wednesday's North American session changing hands for C$1.0372 to the greenback, or 96.41 US cents.

Prices for Canadian government debt were higher across the curve. The two-year bond was up one and a half Canadian cents to yield 1.025 percent, while the benchmark 10-year bond rose 25 Canadian cents to yield 1.942 percent.

The loonie gained marginally against the Australian dollar , another commodity currency, but one that is more closely tied to the fortunes of China due to geographical proximity.

A preliminary survey of manufacturing in the world's second largest economy showed it shrunk in May for the first time in seven months.

Meanwhile, comments from US Federal Reserve chairman Ben Bernanke that monetary stimulus could be scaled back also added to investor caution worldwide.

Bernanke, in testimony to Congress, said the Fed's massive bond-buying program would remain in place for now. But he added if economic improvement continued, the Fed could "in the next few meetings take a step down" in its purchases and warned that holding interest rates too low for too long has its risks.

The dollar initially sold off after Bernanke said monetary stimulus is helping the US economy recover and it was too soon to remove existing measures. It then rebounded and surged to the day's highs as traders focused on the possibility of the Fed reducing its bond buying later this year.

"The takeaway from his speech is clear which is that the Fed is serious about winding down QE and all of the speculation surrounding this possibility is validated," said Kathy Lien, managing director of FX Strategy for BK Asset Management in New York.

"The US dollar has been on a tear since the beginning of the month and should extend its gains now that Bernanke green-lighted the rally."

The dollar has risen more than 5 percent so far this year against a basket of currencies on expectations the beginning of the end of the Fed's bond-buying program might come sooner than originally forecast.

But those hopes faded somewhat this week after several Fed officials dampened speculation the Fed may change its policy stance any time soon.

The dollar rose to a session peak of 103.73 yen, according to Reuters data, the highest since October, 2008. It was last up 0.4 percent on the day at 102.87 yen.

Limiting the dollar's gains, minutes of the latest policy meeting released Wednesday highlighted an active debate over how soon the Fed should start to scale back its bond-buying stimulus, suggesting divisions within policy making committee.

Against a basket of currencies, the dollar index rose to 84.422, the highest since July 2010. It was last at 84.253, up 0.5 percent on the day.

The euro slipped 0.4 percent to $1.2854, retreating from a one-week high of $1.2998 set before Bernanke's speech.

SWISSIE A FOCUS

The euro hit a two-year high against the Swiss franc of 1.2648 francs after Swiss National Bank chief Thomas Jordan did not rule out negative interest rates and said policymakers could adjust the euro/franc currency cap if necessary. It was last at 1.2566, up 0.4 percent.

The US currency climbed to a nine-month peak against the Swiss franc of 0.9838 franc, and was last at 0.9773 franc, up 0.8 percent on the day.

UBS said its forecasts for the euro/Swiss franc and the dollar/Swiss franc are 1.27 and 0.99 in three months' time but there are upside risks to its targets.

The euro hit a 3-1/2-year high of 133.77 yen, before pulling back to 132.33 yen, up 0.1 percent on the day. So far this year, it has gained almost 16 percent.

Traders said the yen was likely to come under more pressure once outflows gather pace, from Japanese investors seeking higher yields overseas.

The Bank of Japan kept policy steady on Wednesday and Governor Haruhiko Kuroda said he did not expect long-term rates to spike given the scale of the BOJ easing and reiterated that there was no change in the goal of achieving 2 percent inflation.

Sterling fell to a two-month low against the dollar after an unexpectedly sharp drop in retail sales sparked concerns the Bank of England could opt for more monetary easing in the coming months.

The Australian dollar fell to a near one-year low of $0.9659 and was last down 1.1 percent at $0.9695.

The plunge left the loonie, as Canada's currency is colloquially known, at its weakest level against the greenback since early June of last year.

Traders saw little reason for the US dollar to reverse its advance after Fed Chairman Ben Bernanke said in congressional testimony that the central bank could scale back its $85 billion a month in bond-buying in the "next few meetings" if economic recovery continues.

The release of minutes from the Fed's last meeting added to market sentiment that the US central bank's so-called quantitative easing program may be wound down sooner rather than later.

"Unless we see contradictory statements that say there will be absolutely no tapering of QE, I can't see the (US) dollar backing off," said Blake Jespersen, a managing director of foreign exchange sales at BMO Capital Markets.

The loonie ended the session at C$1.0372 to the greenback, or 96.41 US cents, after earlier hitting an almost 12-month low of C$1.0388. It closed Tuesday's North American session at C$1.0268, or 97.39 US cents.

Canadian retail sales were unexpectedly flat in March as gasoline prices fell, but economists pointed to a sharp rise in volumes as evidence of a more robust economy.

"The underlying reality is that whilst sales values were undermined by the influence of gasoline sales, the volumes were reasonably OK," said Jeremy Stretch, head of foreign exchange strategy at CIBC World Markets in London.

The loonie fell early in the day on the retail sales figures, recovered a bit, and then was hammered by a flurry of Fed news.

By way of illustrating the greenback's singular strength, the loonie was flat against its commodity-linked cousins, the Australian and New Zealand dollars, but slightly weaker against the euro and British pound .

The price of Canadian government debt fell across the curve, reversing early gains, with longer-dated maturities bearing the heaviest brunt.

The two-year bond slipped more than 4 Canadian cents to yield 1.030 percent, while the benchmark 10-year bond fell 46 Canadian cents to yield 1.964 percent.

But the dollar rose against the yen, a day before the Bank of Japan concludes a two-day policy meeting. Traders widely expect the yen to fall further on expectations Japan will continue its aggressive monetary easing.

The euro rose 0.2 percent to $1.2906, having reached a session peak of $1.2933 and moving away from a six-week low of $1.2795 touched on Friday, according to Reuters data.

Against the yen, the dollar was up 0.2 percent at 102.48 yen , coming off a session peak of 102.88 yen.

Investors scrutinized Fed comments after speculation grew that it is edging closer to tapering bond buying as the labor market improves. Focus now shifts to Fed Chairman Ben Bernanke's testimony to Congress at 10 a.m. 1400 GMT) on Wednesday.

St. Louis Federal Reserve Bank President James Bullard told an event in Frankfurt the Fed should continue quantitative easing, adjusting the pace of bond buying according to incoming data, and said US inflation has recently been below target.

New York Fed President William Dudley said the economy's ability to weather lower government spending and higher taxes in the coming months will be key to the Fed's decision on whether to reduce bond purchases. Both are voting members of the Fed's policy-setting committee.

"Our view remains that Bernanke will not favor near-term 'tapering' at tomorrow's testimony and he will not support 'tapering' before he steps down as Fed Chair in January 2014," said Michael Woolfolk, senior currency strategist at BNY Mellon in New York.

Analysts said if Bernanke reiterates his ultra-loose monetary policy stance, the dollar could give back some of its recent gains, but any suggestion of the Fed winding down asset purchases later this year would give a huge boost to the dollar.

"Bernanke may not be that direct and therefore I would look for implicit clues," said Paresh Upadhyaya, director of currency at Pioneer Investments in Boston. For example, if Bernanke talks about the strength of the US economy or that policymakers are less concerned about the economy, markets may take that as a sign the Fed is closer to an exit, analysts said.

Also on Wednesday, the Fed will release the minutes of its April 30-May 1 policy setting meeting.

The yen had rallied from a 4-1/2-year low against the dollar on Monday after Japanese Economy Minister Akira Amari suggested the yen's strength had been largely corrected.

But on Tuesday, he said he hoped the yen settled at a level justified by fundamentals and at which the impact on imports and exports was balanced.

"It appears that Mr. Amari has been reprimanded by Japanese policy leadership, not a small coincidence considering that the Bank of Japan is meeting and will announce its latest measures, if any, tomorrow," said Christopher Vecchio, currency analyst at DailyFX in New York.

The BOJ, which began a two-day meeting on Tuesday, is expected to keep policy unchanged but could tinker with its bond-buying plan to curb a recent rise in Japanese yields.

The dollar index, which measures the dollar against a basket of other major currencies, rose 0.1 percent to 83.824, not far from Friday's peak of 84.371, its highest since July 2010.

The index has gained 5 percent so far this year on speculation the Fed may start winding down its stimulus sooner than expected.

Some analysts said any near-term dollar weakness would be temporary. The US economy is growing while the euro zone is in recession and the Bank of Japan is committed to flooding the market with liquidity to boost Japanese inflation to 2 percent.

The euro reached a four-month high against the Swiss franc on Tuesday at 1.2529 francs, according to Reuters data, and was last up 0.5 percent at 1.2518 francs. The dollar rose 0.3 percent to 0.9699 franc.

Two senior Fed officials played down the chances that the central bank would signal a readiness to curtail its bond buying program at its meeting next month, dampening earlier speculation spurred by persistent talk from more hawkish Fed officials.

"It's definitely the talk du jour - whether or not the Fed will begin to taper. The market does have a ... sort of expectation that they will start to talk about tapering a little bit sooner," said Mazen Issa, macro strategist at TD Securities.

"Our general view is that, it's still a little bit early to start talking about it...but the market is definitely keeping their ears open."

The US dollar slipped on the latest Fed comments.

The Canadian dollar finished the session at C$1.0268 versus the US dollar, or 97.39 US cents, weaker than Monday's finish of C$1.0241, or 97.65 US cents. Earlier, it touched C$1.0321, or 96.89 US cents, its lowest level since March 7.

Canadian equity and bond markets were closed on Monday for the Victoria Day holiday, leaving most trading desks at Canadian banks unstaffed.

The currency was up from Friday's North American finish of C$1.0291, or 97.17 US cents. It shed about 1.8 percent of its value against the greenback last week.

US Federal Reserve Chairman Ben Bernanke will testify before Congress on Wednesday and market watchers will parse his comments for hints on the direction of Fed policy.

"It seems like they've got a bit of a sustained PR campaign going on it, and the market is reacting accordingly," said John Curran, senior vice president at CanadianForex.

Curran noted that Bernanke himself has not made any comments so far. The US dollar may weaken if Bernanke reiterates his ultra-loose monetary policy stance, but is likely to strengthen further if he provides some hint that asset purchases could be wound down later this year.

In Canada, retail sales figures on Wednesday are the only domestic data before the Bank of Canada issues its next rate announcement next week. The bank is expected to hold rates steady.

Analysts polled are expecting a 0.1 percent increase in retail sales in March.

"There's probably some scope for some weakening in the Canadian dollar just given that our expectation is that we're actually going to see a modest decline in retail sales. The market's just looking for a very modest positive," Issa said.

The price of Canadian government debt was generally higher across the curve. The two-year bond was flat, with a yield of 1.010 percent, while the benchmark 10-year bond rose 12 Canadian cents to yield 1.913 percent.

Market focus is shifting to Bernanke's testimony to Congress on Wednesday after recent comments by Fed officials have fueled speculation the US central bank may trim its bond purchases sooner than expected.

The yen rebounded from a 4-1/2-year low against the dollar after Japan's Economy Minister Akira Amari said the yen's excessive strength had largely corrected and that further weakness could damage Japan's economy.

"We may have been moving a little bit too early," said Andrew Dilz, foreign currency trader at Tempus Inc in Washington. "I see a continuing of this exact pace of current purchases at least through the end of the summer, which is going to put some pressure on the dollar."

The dollar index, which tracks its value against a basket of currencies, fell 0.6 percent to 83.788, retracing from a near three-year peak notched on Friday.

Speculation had grown that the beginning of the end of the Fed's $85 billion per month bond-buying program might come sooner than many investors expected if recent gains in the US labor market hold.

The roughly 50 percent jump in monthly job creation since the program began has raised at least some chance the Fed could start to ratchet back its buying as early as next month. The central bank next meets to debate US monetary policy on June 18-19.

Chicago Fed President Charles Evans said the US central bank could keep up its current level of bond-buying stimulus, but may end it abruptly in the autumn if by then it was sure that the labor market was on a solid footing.

The dollar fell 0.9 percent to 102.25 yen, having hit a session low of 102.16, according to Reuters data. Last Friday, the dollar touched a high of 103.30 yen.

The euro lost 0.6 percent to 131.76 yen and its low on Monday at 131.02 was the lowest since May 9.

The Bank of Japan, which begins a two-day meeting on Tuesday, is expected to keep policy unchanged but could tinker with its bond-buying plan to curb a recent rise in Japanese yields. Analysts said the yen looked set to resume its recent weakening as Tokyo was committed to easier monetary policy.

"Any dip in dollar/yen toward 101 or 102 yen is a buy as Japanese policymakers are clear that there will be more asset purchase or quantitative easing in the longer term," said Alvin Tan, a currency strategist at Societe Generale in London.

He also said short-term momentum indicators such as the 14-day relative strength index showed the dollar was overbought against the yen, meaning a pullback was due.

The euro rose 0.4 percent to $1.2887, having touched a session peak of $1.2894, and rebounding from a six-week low of $1.2795 touched on Friday.

But some analysts say additional gains would be limited, given strong expectations the European Central Bank will cut its deposit rate - the rate paid on surplus cash parked by banks - below zero in coming months.

JPMorgan lowered its second-quarter euro/dollar forecast to $1.30 from $1.32 to reflect a shallower US downturn, slower growth in China and a protracted euro zone recession.

Any hint of the Fed winding down its asset purchases could add the dollar's momentum, analysts said.

"We are dollar bulls and expecting more pieces of the puzzle to fall into place - most notably serious speculation over the normalization of Fed policy, which can drive US money market rates and the dollar substantially higher," Chris Turner, head of currency strategy at ING in London, wrote in a research note.

The Fed is slated to release the minutes of its most recent policy meeting on Wednesday.

The dollar weakened against other major currencies, with sterling up 0.6 percent on the day and the Australian dollar up nearly 1 percent. The New Zealand dollar rallied 1.3 percent against the greenback.

At 2100 GMT, the euro was at $1.2884 compared to $1.2834 late Friday.

The dollar fell to 102.26 yen from 103.19, while the euro moved to 131.76 yen from 132.44.

The dollar mostly traded in a narrow range in the absence of fresh economic data and in anticipation of Wednesday's testimony on the economy by Federal Reserve Chairman Ben Bernanke and the release, the same day, of minutes from the Fed's last policy meeting.

The yen's push higher came after Economy Minister Akira Amari suggested that further weakening of the yen could be harmful after a long, steady fall from last year.

"It's being said that the correction of the strong yen is largely completed. If the yen keeps on weakening a lot more, it will have a negative impact on peoples' lives," he said.

"The comments from Mr. Amari suggest the government appears to be satisfied at the levels achieved by the yen at present," said analysts at FXstreet.com.

Some traders used Amari's comments as "an excuse to take profits after the dollar breached 103 yen," said Daisaku Ueno, senior forex strategist at Mitsubishi UFJ Morgan Stanley.

The British pound also pulled back, rising to $1.5258 from $1.5176. And the dollar slipped to 0.9667 Swiss francs from 0.9716 francs.