The dollar slipped against the euro on Friday on tame inflation data, but rallied to a fresh 4-1/2-year high against the yen after the Bank of Japan indicated it was in no hurry to raise interest rates.
The greenback has touched fresh highs against the yen for the past three sessions and posted its biggest weekly gain against the yen so far this year after buyers pushed the US currency up through several technical resistance levels against the Japanese currency.
The euro was up 0.5 percent from late Thursday to $1.3381 following reports showing core consumer prices, which exclude food and energy, rose in May at the slowest pace since March 2006, factory output slowed and consumer confidence dropped more sharply than expected. It was the euro's biggest one-day percentage gain against the dollar in two months.
The data has capped a dollar rally that has been largely fuelled by US Treasury yields climbing this week to five-year highs, which had outpaced the rise in yields of other major government debt.
"The big move this week was the sell-off in bonds which caught a lot of people by surprise," said Joe Francomano, vice president of foreign exchange at Erste Bank in New York. "That was the impetus for the dollar/yen to break through all the barriers from 122 to 123.50."
Over the past month, data has hinted at a rebound in US growth, and traders of interest rate futures priced out expectations of an interest rate cut by the Federal Reserve.
In March, dealers priced in nearly three quarters of a percent in cuts. "Bond yield developments have been driving other markets for the past week or so, and an easing in yields should equate to a softer dollar," said Nick Bennenbroek, head of currency strategy with Wells Fargo in New York. Against the yen, the dollar rose to a high of 123.66 yen, before it surrendered some gains to trade at 123.46, up 0.5 percent on the day.
Japan's interest rates, which at 0.5 percent are the lowest in the developed world, continue to weigh on the yen, especially after the Japan's central bank ended a policy meeting with no clear signals of a forthcoming rate increase.
The euro rose to a record high of 165.27 yen, according to electronic platform EBS, before surrendering some gains to trade at 165.17 yen, up 1 percent on the day. Despite Friday's pullback in the dollar against the euro, many analysts anticipated strength in the currency next week. "Although the market remains short dollars and reluctant to embrace the greenback for any length of time, we expect the dollar to make further gains next week on further paring of dollar shorts and positive US data surprises," said Michael Woolfolk, senior currency strategist with the Bank of New York.
Though currency investors continue to be focused primarily on milking yield out of differences in interest rates between various currencies, data released on Friday showed a long-term weakness in the dollar has improved somewhat.
A report showed the US current account deficit widened in the first quarter but by less than expected to $192.58 billion from $187.94 billion in the fourth quarter of last year. Also on Friday, the deficit for full-year 2006 was revised down by $45 billion to $811.48 billion.
While still massive - the 2006 shortfall was equivalent to 6.1 percent of US gross domestic product - the current account gap appeared to be stabilising below $200 billion on a quarterly basis. A separate report showed long-term net capital flows into the United States rose in April to $84.1 billion, the highest since January, driven by record net foreign purchases of US stocks by private investors.