The yen drifted off a one-week high against the dollar on Wednesday thanks to a general improvement in risk appetite, paring gains made after the Bank of Japan balked at delivering a surprise for markets. The euro also hovered above last week's lows after a solid Italian debt auction and data showing the Spanish economy contracted slightly less than expected in the third quarter.
The dollar was at 79.59 yen, almost flat on the day but recovering from a fall to 79.28 when the market unwound long dollar/yen positions after the BoJ expanded its asset-buying programme by 11 trillion yen ($138 billion) in a broadly expected move. Hopes of easing by the BoJ helped to lift the dollar last week, to a four-month high of 80.38 yen. But in reality, the BoJ's easing is unlikely to lead to sustainable weakness in the yen, said Taisuke Tanaka, FX strategist at Deutsche.
"If the global and domestic economy gets worse, the BoJ could take bolder steps, but at the same time the yen tends to rise as a currency of a creditor nation. If the economies are improving the BoJ will hesitate to ease," he said. Rather, US bond yields are likely to hold the key for the currency pair, Tanaka added.
The dollar is likely to return to its familiar range near 77-78 yen, with the immediate focus on how US markets will react to the damage caused by Hurricane Sandy. "The damage to the US economy from Hurricane Sandy could be huge. If US bond yields fall sharply, that is likely to send the dollar/yen lower," said Tohru Sasaki, the head of Japan rates and FX research at J.P. Morgan Chase Bank.
The dollar/yen rate has historically had a high correlation with US bond yields. On Wednesday, US 10-year yields were little changed from their levels before the hurricane shut down New York markets on Monday. That saw the safe-haven yen give back all of its gains against the euro and Australian dollar. The euro climbed to 103.16 yen, bouncing back from a two-week low of 102.18, marked on Tuesday.
Against the dollar, the single currency was flat at $1.2963, having again found good support just below $1.2900. That helped keep the single currency well within its $1.2800-$1.3200 range seen since mid-September. The Australian dollar ticked up near the top-end of its $1.0200/$1.0400 range to stand at $1.0375 after upbeat Australian housing data. Also late on Tuesday, Australia's central bank deputy governor said the local currency was not fundamentally overvalued and set a very high bar for intervening to weaken it.