The yen fell against other major currencies on Monday, giving up earlier gains made in the wake of China's rate hike as a rebound in the Nikkei share average eased fears about investors further cutting back on riskier assets.
The Nikkei rose more than 1 percent after a weak start while China's benchmark stock index rebounded after dropping at the opening and climbed 2.9 percent
The yen gained earlier in the session after China raised interest rates over the weekend for the third time in less than a year, stirring worries the move could rattle equity markets.
But the resilience of stock markets bolstered some investors' appetite for risk. The yen has been weighed down as market players built carry trades that use low-yielding currencies like the yen as a cheap source of funds to buy higher-yielding assets.
The dollar rose to 117.26 yen as, helped by buying by hedge funds and Japanese importers, after extending gains more than 1 yen from a low of 116.25 hit earlier in the session.
The euro rose to 156.04 yen up from around 155.40 yen in late US trading on Friday, and sterling rose to 227.72 yen up from 226.37 yen. "It's the speculators who are making the market very volatile," said a trader at Japanese trust bank.
"They had no more reason to buy yen beyond the morning high, and they flipped positions back to sell yen to make money in a thin market," he said.
China's central bank said on Saturday it was raising its lending and deposit rates by 0.27 percentage point, taking the one-year benchmark deposit rate to 2.79 percent and the lending rate to 6.39 percent to put a lid on credit and investment.
But equity markets in Asia were firm as traders said the rate hike had been expected and they did not foresee a large impact in the short term. While price action may remain volatile, investors' focus is shifting to a meeting of the Federal Reserve this week.
A growing concern that the US subprime mortgage crisis could hurt the broader economy and prompt the Fed to cut interest rates sent the dollar down to a three-month low against a basket of currencies in the previous session.
The Fed is expected to keep interest rates unchanged at 5.25 percent at a two-day policy meeting that ends on Wednesday, and investors are waiting to see what the Fed will say about the state of the US economy in its post-meeting statement.
Any statement that bolsters market expectations for the Fed to cut rates this year could spark dollar selling, traders say.
"Depending on how the Fed words its description of the state of the economy, more position adjustments to sell the dollar may emerge," said Hideaki Inoue, chief manager at FX trading at Mitsubishi UFJ Trust Banking.
The dollar edged up to 83.31 against a basket of six major currencies after sliding as far as 83.03 on Friday, its lowest since early December. The euro inched down to $1.3303 after hitting a three-month high of $1.3340 on Friday.
The yen seems more vulnerable to falls on the crosses than against the dollar, said Tomoko Fujii, a senior economist and strategist at Bank of America.
"The outlook for the dollar is unclear, so people may decide to target cross/yen, especially currencies backed by hopes for interest rate increases," Fujii said, adding that the Australian dollar is one currency that may be poised to rise versus the yen.
The Australian dollar, which received a boost on Friday from hawkish comments by a top Australian central banker, rose to 93.23 yen up from 92.81 yen in late New York.
The Bank of Japan ends a two-day meeting on Tuesday, but traders expect little impact on the market as the central bank is widely seen holding rates steady after lifting them in February to a decade-high 0.5 percent.
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