The yen resumed this week's broad rally on Thursday, hitting a 2007 high against the dollar, as stock market declines across Asia made investors edgy about a further slide in risky assets.
Falls in global stock markets, a rise in the price of oil, growing tensions over Iran's nuclear programme and a run of weaker than expected US data have all contributed to a sharp fall in risk appetite in recent sessions. As a result, investors have become less comfortable about borrowing cheaply in yen or Swiss francs to fund investments in higher yielding units such as the dollar, euro or sterling.
The unwinding of such carry trades drove the low-yielding Japanese currency up for its largest one-day gain in 14 months against the dollar earlier this week.
"Asian equities are still under downward pressure and clearly there remains a tendency to unwind carry trades, to take out risk .. so consequently we see both the Swiss franc and the yen performing very well," said Michael Klawitter, currency strategist at Dresdner Kleinwort in Frankfurt.
Japan's top financial diplomat Hiroshi Watanabe said he was closely monitoring yen carry trades and the impact from their possible reversal. He estimated the size of the carry trade at between 10-20 trillion yen but said there were no statistics available.
He also said that while carry was not easily reversible, investors should not be complacent and recognise two-way risk as discussed at February's Group of Seven meeting.
By 1313 GMT, the dollar had slipped 0.7 percent to 117.35 yen, its lowest since mid-December 2006. The euro shed 0.8 percent to 155.42 yen. Stock indices in Japan, Taiwan and Shanghai fell on Thursday, building on Tuesday's sharp sell off, although European equities edged up in early trade.
Japan's vice finance minister Hideto Fujii said that he will watch stock market moves closely as one kind of economic indicator. He added that the economy remains supported by prolonged strength in the corporate sector.
The single European currency was flat at $1.3221, off the two-month high around $1.3260 struck on Tuesday. It showed little reaction to data showing that eurozone inflation stayed at 1.8 percent year-on-year last month, and growth in the manufacturing sector picked up slightly.
Markets are fully priced for an ECB hike to 3.75 percent next week and most expect more tightening later this year. A survey of the US manufacturing sector, from the Institute for Supply Management, is due at 1500 GMT. A series of soft data has stoked more worries about a sharp economic slowdown and the Fed needing to cut interest rates from the current 5.25 percent later in the year, which would undermine the dollar's yield advantage.
The ISM is forecast to rise to 50.0 from 49.3 in January, which would show a stagnant factory sector. Data on US personal income and spending for January will be released at 1330 GMT. Spending is expected to have risen 0.4 percent compared with the previous month, slowing from a 0.7 percent increase in December.
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