The yen climbed on Thursday as worries about a possible near-term interest rate hike in China to slow its accelerating economy prompted investors to unwind trades funded by low rates in the Japanese currency.
Any slowdown in China as a result of higher rates could crimp demand for emerging market and other risky assets that have supported the carry trade, a strategy in which investors borrow cheaply to buy higher-yielding assets or currencies.
The yen trimmed earlier gains against high-yielding currencies such as the US, Australian and New Zealand dollars but most analysts saw that as a temporary setback for the yen.
"Demand for carry trades fell this morning, with the yen rebounding against most major currencies, said Samarjit Shankar, a director for foreign exchange at Mellon Financial Corp in Boston. "It's a knee-jerk reaction to the possibility of higher interest rates in China."
In early afternoon trading, the euro was slightly lower on the day against the yen at 160.99 yen, after having fallen 1 percent. The dollar recovered from lows of 117.62 yen to trade at 118.39.
The Australian dollar trimmed losses against the yen to 98.84 yen, but was off a decade high above 100 yen hit this week. The New Zealand dollar also came off lows at 88.05 yen along with sterling, which traded at 236.95 yen, from intraday lows of 235.27.
Data showed that China's economy grew at a blistering 11.1 percent annual pace in the first quarter and March inflation rose above the central bank's 3 percent comfort level. The numbers fuelled speculation that interest rates would need to rise again soon to tighten credit, a view enhanced by Premier Wen Jiabao's comments that the country needed to take measures to prevent economic overheating.
China's robust economy has contributed to strong growth in emerging economies that export commodities, raising concerns that any slowdown in the world's fourth-largest economy would reduce demand for emerging market assets generally.
Chinese stocks lost 4.5 percent on Thursday, the sharpest drop since February 27 when the Shanghai Composite Index slump 9 percent, roiling world markets. Equity markets in Asia and Europe fell, adding to expectations investors will unwind carry trades.
The drop in Chinese stocks sent global stocks lower and government bonds in Europe and the United States higher. By early afternoon trading, US stock indexes were flat. Sterling was down 0.4 percent at $2.0009 after hitting a 26-year peak on Wednesday.
The dollar moved away from a two-year low against the euro, as investors awaited a speech from the San Francisco Federal Reserve president for more clues on US interest rate policy. The euro was flat at $1.3599 after notching a two-year high of $1.3619 earlier in the day and still in sight of the record high at $1.3670 set in December 2004.