The yen fell to a five-week low against the euro and a one-month trough versus the dollar on Tuesday as improving risk appetite on the back of firmer stocks prompted investors to chase high-yielding currencies.
Investors remained on data watch ahead of this week's key US employment report, after soft US manufacturing data on Monday failed to shake expectations for the Federal Reserve to cut rates at some point later this year.
Given Tuesday's light data calendar, investors focused on the diverging rates outlook which will leave the yen, the lowest yielding currency in the industrialised world, the major loser.
"It's premature to look for the yen to strengthen. The combination of loose (monetary) policy and strong outflows will continue to drive the yen weaker," said Steven Saywell, currency strategist at Citigroup. "We tend to think the worst part of the US housing downturn is already over. Dollar weakness is coming to an end," he said, adding that Friday's jobs data could surprise on the upside and help the dollar.
By 1130 GMT, the euro was up 0.6 percent at 158.50 yen after hitting 158.53, last seen on February 27 when investors rushed to buy back the Japanese currency and unwind carry trades as global equity markets tumbled. The dollar was up 0.6 percent at 118.57 yen while it was up 0.2 percent at 1.21872 Swiss francs.
The yen hit a 5-week low of 234.82 per sterling as the pound strengthened broadly as speculation grew the Bank of England might raise interest rates from 5.25 percent on Thursday.
The euro was steady at $1.3365, holding between $1.3300 and a two-year high of $1.3411 hit in March. One key driver of carry trades has been Japanese domestic investors who, frustrated by low rates at home, purchased higher-return overseas assets abroad - a trend set to accelerate after the new fiscal year started on Monday.
Carry trades will remain at the mercy of risk appetite, but key indices were showing healthy conditions for risk. The IMF/State Street Risk Appetite Index has hit 0.79, the highest level since September 2005, while the UBS Risk Index also stayed in a risk-seeking territory.
Investors awaited US payrolls data on Friday for clues on the Fed outlook, as well as central bank meetings in Australia and Britain this week. The Australian dollar hit a 10-year high versus the yen and held near Monday's decade high against the dollar ahead of an Australian interest rate decision, where the market sees a better than even chance of a rate hike to 6.5 percent.
"Should the RBA indeed hike rates, the question for AUD will be whether it can break above US $0.82 on a sustained basis; such a move could open the door for further short-term gains," J.P. Morgan said in a note to clients.
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