The yen strengthened to highs around 110.30 against the dollar in Europe on Thursday as equity markets weakened and, although the US currency was able to strengthen temporarily back towards 111.0, the yen regained ground later in US trading. As regional stock markets came under pressure on Friday, the yen briefly strengthened through 110.0 with the dollar struggling to secure any significant relief.

The yen is still gaining underlying support from a reduction in high-yield trades, especially with uncertainty over global credit trends. The rise in inter-bank rates has reinforced the fears of a liquidity squeeze and is increasing the underlying pressure for a reduction in carry trades. Any forced global liquidation could put the yen under strong upward pressure.

The Bank of Japan has taken a more cautious stance on the economy, warning over a potential negative impact from the US downturn, and this will reinforce expectations that the bank will not increase interest rates in the short term. The Finance Ministry is likely to oppose short-term yen gains much beyond the 110.0 level with volatility liable to remain high.