The yen fell sharply on Monday as some investors bet that Japanese interest rates would stay far lower than those of other major currencies even after an expected end to the Bank of Japan's ultra-loose monetary policy.
The BoJ is seen ending its five-year-old "quantitative easing" policy as early as this week, and many market players expect the central bank to raise rates from virtually zero by the end of the year.
But the dollar's failure to hold convincingly below 116 yen last week despite mounting speculation for a BoJ policy shift encouraged investors to pile back into higher yielding currencies including the US and Australian dollars, traders said.
"We're seeing continued interest from Japanese investors to sell the yen and go for yield," said Noriyuki Kato, treasury manager at State Street in Tokyo. "And the market has already jumped on the BoJ issue so by the time the fact comes out it could be a non-event."
The dollar hit one-month lows against the euro, Swiss franc and sterling on Monday, dented versus the euro-zone's currency by growing expectations that the European Central Bank will keep boosting interest rates.
The euro built on a 2 percent gain against the dollar last week, boosted in part after the ECB raised rates to a three-year high and the central bank chief, Jean-Claude Trichet, revised up his inflation forecasts for 2007.
The euro was buying $1.2065, up around 0.2 percent from the level in late New York trade on Friday. It climbed as high as $1.2094 on electric trading platform EBS, a one-month peak.
The dollar was trading at 117.00 yen after shooting up a full yen on the day to as high as around 117.15 yen. Traders said that Japanese importers and mutual funds were selling yen and that stop-loss triggers had exacerbated losses.
The yen's fall was just as severe against the euro which broke above key technical resistance at 141 yen and was also up a full yen on the day. The yen had briefly risen to a one-month high of 115.45 per dollar last week on growing speculation that the BoJ was close to ending its ultra-loose policy, but it has repeatedly failed to hold gains beyond 116 yen over the past week.
Traders said the dollar would likely stay in a range between 115 yen and 117 yen ahead of the BoJ's two-day policy meeting that kicks off on Wednesday.
About half of the market participants in a Reuters poll on Friday said they expect the central bank at this week's meeting to end the quantitative easing policy of flooding the banking system with excess funds.
BoJ Governor Toshihiko Fukui told a parliamentary committee on Monday that he did not hold any preconceptions going into the meeting, which follows consumer price data last week that suggested Japan is breaking free from a near decade-long bout of deflation.
Some analysts said that investors were also cautious about buying the dollar ahead of a meeting of the UN's atomic watchdog later in the day to discuss Iran's nuclear ambitions.
"Rising tension (between Iran and the West) could have an impact on oil prices and that is a negative factor for the dollar," said Junya Tanase, forex strategist at J.P. Morgan Chase Bank in Tokyo.
The International Atomic Energy Agency is set to move the case to the UN Security Council, opening the way to possible action by the council over worries that Tehran wants to build atomic bombs.
Market players worry such action could prompt Iran - the world's fourth-largest oil exporter - to cut off oil supplies.
Besides the BoJ, central banks in Canada, Australia, England and New Zealand are due to hold policy-setting meetings this week.
Only the Bank of Canada is expected to adjust interest rates, with a quarter percentage point rise to 3.75 percent.
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