The Australian dollar rose thanks to strong data and record gold prices on Tuesday, dragging down the Japanese yen, a popular source of cheap funding for investments in high-yielders like the Aussie.
The US dollar steadied against a basket major currencies. Analysts said a lot of bad news on the world's biggest economy is already priced into the market and US pending home sales data at 1500 GMT would need to be particularly weak to spark a fresh bout of dollar selling.
Despite worries about a US economic slowdown, and possibly even a recession, risk appetite recovered a little on Tuesday, cheered by gains in European equity markets.
That gave forex players the excuse to re-enter some yen-funded carry trade bets on high yielding currencies, which had been sharply unwound in the first few trading days of 2008.
"We had a lot of risk aversion in the market at the start of the year and it appears there has been some profit-taking on this...with the yen weakening somewhat," said Niels From, currency strategist at Dresdner Kleinwort in Frankfurt.
"The data we got out of Australia was fairly strong, which is helping the Aussie dollar, and this combined with the cautious risk appetite is helping the carry trade."
The Aussie rose 1.2 percent to 96.38 yen, and gained nearly one percent versus the US dollar to trade at US $0.8790 by 1103 GMT, cheered by gold prices hitting record highs above $870 an ounce and data showing strong growth in Australian building approvals. Canada, another gold producer, also saw its currency strengthen versus the US dollar.
YEN PRESSURED: The dollar was up 0.4 percent at 109.59 yen but still well below the 114 yen level seen just before the new year. The euro rose half a percent against the yen to 161.16 yen. The yen - with interest rates of just 0.5 percent - had benefited at the start of the year as poor US jobs data and falling equity markets led to heightened risk aversion.
The dollar index was steady at 76.125. The euro edged up to $1.4704, pulled up by its gains against the yen, but remained below Friday's five-week high of $1.4824. Weaker-than-expected eurozone retail sales data for November did not alter expectations that the European Central Bank will leave interest rates on hold this week.
"We expect the ECB to confirm this Thursday that rates are on hold at 4 percent but that the ECB maintains some tightening bias and would be ready to act if wage inflation accelerates," Bank of America said in a research note.
"For the time being the ECB is far away from contemplating a rate cut despite softer growth, in our view." In the United States, many market players believe the Federal Reserve is likely to cut rates by a half percentage point at its late January meeting to 3.75 percent. A quarter-point cut is seen as virtually certain.
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