The dollar fell more than half a percent against the yen on Friday as investors bet that Japan's Prime Minister Junichiro Koizumi is likely to win support in Sunday's election, enabling him to maintain the country's economic reforms.
The dollar slipped as far as 107.97 yen, its lowest in eight days, and the euro fell 0.7 percent to 133.86 yen as dealers bought the yen on sentiment that Koizumi's ruling coalition party could amass enough votes to boost its seats in the upper chamber. However, if Koizumi were to lose, traders said, the yen could weaken sharply.
"We have seen a (yen) appreciation on the notion that Koizumi will hold on to his post and that he will stay on the same course as far as economic reforms go," said David Leaver, senior trader at GAIN Capital, an online currency trading firm in New Jersey.
"If he loses, there will be a sharp reaction the other way, back toward 110 (in dollar/yen) and back toward 135 (in euro/yen) two very key levels," Leaver added.
Koizumi's ruling coalition cannot be ousted from power as a result of the election for parliament's upper house, as it holds a majority in the powerful lower chamber. But a poor showing would weaken his clout and might invite calls for his resignation.
The dollar held steady against the euro and the Swiss franc on light pre-weekend buying after falling to 3-1/2-months low against the euro and to five-months low against the Swiss franc.
The dollar has been pressured by diminishing expectations on US interest rate hikes and security concerns.
But investors were buying back what they saw as the over-sold dollar ahead of the weekend to square their books before a week of fresh US economic data. Next week markets will see inflation data, retail sales and trade reports, among others.
"Today the risk would be that after the dollar decline, there could be some potential retracement ahead of the weekend; not necessarily that significant unless key levels on the downside are broken," said Robert Lynch, currency strategist at BNP Paribas in New York.
Mixed US economic data, weak corporate results and the Federal Reserve's insistence on a "measured" pace of future monetary tightening have put pressure on the dollar.
If yields on US bonds rise only modestly, such dollar-denominated assets may be less attractive to foreign investors.
The euro hit highs at $1.2423 before easing to around $1.2398. The dollar hit lows versus the Swiss franc at around 1.2220 francs before rising to 1.2239 francs in New York trade. Against the Canadian dollar, the US unit fell to 3-month lows at C$1.3143.
The market ignored US wholesale inventory and sales data, released on Friday, but investors were eyeing a speech by Kansas City Federal Reserve President Thomas Hoenig and US corporate earnings reports.