The dollar slid to a two-month low against the euro on Tuesday as investors looked beyond an expected Federal Reserve interest rate rise for clues about how much more credit tightening the central bank plans.
The yen gained support from the Nikkei stock average rising about 1 percent and data showing a solid increase in June machinery orders, with worries quickly fading about the foggy political outlook in Japan ahead of the September 11 election.
"Apparently Japanese financial markets are not too worried about the election, and the good data can compensate for the political uncertainty," said Tomoko Fujii, senior currency strategist at Bank of America in Tokyo.
But all eyes were on the Federal Open Market Committee (FOMC) meeting. The central bank is widely expected to deliver its 10th straight 25 basis point increase, taking its overnight funds rate to 3.5 percent.
Most analysts expect the Fed's post-meeting statement, due around 1815 GMT, to repeat that more measured credit tightening is ahead.
The dollar's widening rate advantage had helped to boost the currency 9 percent against the euro and the yen this year, but in the past month the US currency's rally hit a wall as investors already expect US rates to keep climbing higher.
The euro had struck a fresh two-month high against the dollar, rising as high as $1.2418 on electronic trading platform EBS after taking out technical resistance and stop-loss orders near $1.24, traders said.
The US currency was down 0.4 percent at 111.75 yen. Some Japanese investors bought the yen to repatriate coupon payments on US Treasuries, traders said.
The single currency was little changed around 138.60 yen but near a three-and-a-half month high of 138.84 yen hit on Monday.
A Reuters poll after last week's US jobs data found fewer US primary dealers expect the Fed to pause its credit tightening campaign this year, which would lead to a year-end rate of 4.25 percent.
More economists see the rate ultimately rising to 5 percent or higher.
Economists at Goldman Sachs changed on Monday their fed funds forecast to 5 percent from 4.5 percent, saying that stronger growth, a tightening labour market and relaxed financial conditions "all put pressure on the FOMC to keep going".
As expected, the Bank of Japan kept its ultra-easy monetary policy unchanged at the end of a two-day meeting on Tuesday as debate dragged on about tweaking its target for the amount of cash pumped into the banking system.
Overnight rates in Japan remain virtually zero while euro zone rates stand at 2 percent.
The yen quickly recovered from a three-and-a-half month low versus the euro hit on Monday when Japanese Prime Minister Junichiro Koizumi followed through on a threat to call a snap election after parliament voted down his prized postal reform bills.
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