The yen hit a 2-1/2 week low against the euro on Monday and fell versus the dollar, giving up gains made after China's interest rate hike, as rebounding stock markets gave investors more confidence in taking on risk.
Yen-financed and high-risk carry trades took a hit earlier in March as falling stocks fuelled risk aversion, prompting investors to buy back low-yielding currencies like the yen.
Investors have since dipped their toes back into carry trades, pushing high-yielders such as the Australian and New Zealand dollars higher in the process, as stock markets trimmed losses.
They are still cautious ahead of key interest rate decisions from the Federal Reserve and the Bank of Japan later this week.
"The correlation with equity markets and the yen is very strong...It's reflective of an increase in appetite again for riskier assets and hence carry trades," Mitul Kotecha, head of global foreign exchange research at Calyon, said.
"Also we can't ignore entirely the economic circumstances in Japan - the Bank of Japan meets this week but it's very unlikely that we'll see a move in rates," he added.
The euro rose to a 2-1/2 week high of 156.34 yen, before retreating slightly to 156.15 by 1200 GMT - still up 0.3 percent on the day. The dollar was up 0.6 percent at 117.45 yen, after hitting a three-month low of 115.13 earlier this month.
China raised interest rates over the weekend for the third time in less than a year to trim credit and investment growth and cool down the world's fourth-largest economy.
The yuan briefly touched 7.330 to the dollar in early Beijing trade, its highest level since it was de-pegged from the dollar in July 2005, before retreating to 7.7360. But stock markets proved resilient, with Tokyo's Nikkei share average ending up 1.59 percent. European stock markets were firmer while US stock futures are indicating a higher open on Wall Street later. The euro was down slightly on the day at $1.3293 after hitting a three-month high around $1.3340 on Friday. While price action may remain volatile, investor focus is shifting to key interest rate decisions.
The Fed is expected to keep interest rates unchanged at 5.25 percent at a two-day policy meeting that ends on Wednesday, and investors are waiting to see what it will say about the state of the US economy in its post-meeting statement.
A growing concern that the US subprime mortgage crisis could hurt the broader economy and prompt the Fed to cut interest rates sent the dollar down to a three-month low against a basket of currencies in the previous session.
"A dovish statement would be USD-negative on the face of it, but more so against the euro than the yen. Such Fed dovishness would be comforting for equities and emerging markets and could offer some support for the weak JPY argument," Mellon Bank head of currency research Ian Gunner said.
The Bank of Japan ends a two-day meeting on Tuesday, when the central bank is widely seen holding rates steady after lifting them in February to a decade-high 0.5 percent. "We think the BoJ will raise rates again, but probably not for another six months, so maybe as we move into the fourth quarter," Calyon's Kotecha said.