The low-yielding yen jumped around 1.5 percent against the euro and 1 percent versus the dollar, while high-yielders slid on Thursday as investors cut exposure to carry trades due to worries over problems in credit markets.
US and eurozone short-term money market borrowing rates soared as banks scrambled for cash amid deepening concern about credit market losses, forcing the European Central Bank to inject extra funds into the system in a quick overnight tender.
The surge in US short-term rates boosted the dollar against other currencies, including the euro, which fell almost half a percent against the greenback.
Earlier, French bank BNP Paribas said three of its funds were hit by problems in the US subprime mortgage sector and decided to temporarily suspend redemption's from the funds, prompting a sharp pullback in FX carry trades, a fall in equities and a rally in government bonds.
Investors had tentatively dipped their toes back into carry trades - borrowing yen to fund purchases of high-return assets - on Wednesday, encouraged by calmer financial markets after the US Federal Reserve cooled expectations for a rate cut.
The Fed also acknowledged market turbulence caused by credit market jitters but maintained economic growth would continue. But worries about the impact on the wider economy from problems in the US subprime market, which extends credit to borrowers with poor credit histories, refused to subside.
"The market still remains very fragile in terms of sentiment and is very susceptible to negative shocks that impact the credit market," said Bank of America currency strategist Kamal Sharma. "This is a picture right across the spectrum, where liquidity is drying up considerably," he added.
By 1141 GMT, the dollar was down 0.9 percent on the day at 118.54 yen, while the euro slid 1.4 percent to 162.71 yen. The single currency slipped 0.5 percent to $1.3728, moving away from July's record high of $1.3852, according to Reuters data. The dollar index, a measure of the greenback's value against a basket of six heavily traded currencies, was up 0.3 percent at 80.55.
Both currencies had been supported in Asian overnight trade as solid employment data in both countries reinforced the outlook for policy rates to stay high at 6.5 percent and 8.25 percent respectively.
The ripple of risk aversion stopped European stocks from tracking Asian gains overnight, with the FTSEurofirst 300 index down 1.5 percent at 1,529.87 and US stocks pointing to a sharply lower open. "There is nothing else driving markets at all other than risk aversion or risk appetite driven by how concerned the market is about subprime," RBC senior currency strategist Adam Cole said.
Fears about the fallout from rising US subprime mortgage defaults and spreading losses in credit markets have spooked investors in the past few weeks. Several major US companies have announced losses from exposure to these subprime loans, sending jitters across the financial services sector.