Dollar falls vs yen as risk cut after Bernanke

The dollar slid towards a recent seven-month low versus the yen on Thursday after Federal Reserve Chairman Ben Bernanke expressed concern about the U.S. economy but steered clear of hinting about further easing as some had hoped.

The euro, which lost sharply after his comments sparked outflows from stocks and other risk assets, held steady at lower levels ahead of Europe's bank stress test results on Friday.

Bernanke, in testimony prepared for delivery to the Senate Banking Committee, said the U.S. economy faces unusually uncertain prospects.

That 'unusually uncertain' phrase from Bernanke was very strong, prompting investors to sell stocks and buy government bonds, said a trader at a big Japanese bank.

But in the forex market, investors are unable to react much before the stress test results, the market's main focus.

Although Bernanke said the Fed was ready to take further steps to bolster growth if needed, analysts said lack of clarity on what measures it could take prompted investors to reduce risk positions, benefiting the low-yielding yen across the board.

The dollar fell 0.7 percent to 86.47 yen JPY=, extending losses after a 0.5 percentage point fall on Wednesday, on a mixture of offers from Japanese exporters and hedging selling related to some currency-linked structured notes.

Traders said the dollar could fall fast if it breaks below a seven-month trough of 86.27 yen hit last week, with stop-loss dollar offers believed to be waiting below that level.

A relentless drop in U.S. bond yields is also reducing the allure of the dollar in comparison with the yen.

The two-year U.S. Treasury note yield fell to a record low around 0.56 percent following Bernanke's comments, shrinking the yield spread of two-year U.S bonds over Japanese government debt to a fresh 15-month low.

Others were less convinced about the likelihood of further falls in the dollar.

The pair's 14-day relative strength index is at 33, near the 30 mark considered to indicate an oversold market.

Yuki Sakasai, a forex strategist at Barclays Capital, said the dollar/yen rate was unlikely to fall much below the seven-month low for now.

What Bernanke has said is essentially the same as the minutes (of the Fed's June 22-23 meeting). So his comments alone are unlikely to push the dollar/yen below recent trading ranges, Sakasai said.

The rise in the yen, which gained steeply on the crosses on Wednesday, has been hampered by caution that Japanese policy makers may try to talk it down as it nears a 14-year high around 85 yen per dollar hit last November.

Deputy Finance Minister Motohisa Ikeda said on Thursday Japan wants to avoid excessive rises in the yen, but market reaction was muted.

The euro was up 0.2 percent at $1.2781 EUR=, winning some reprieve after having lost nearly 1 percent on Wednesday on Bernanke's comments and tepid demand at a Portuguese debt sale.

It has some support at its 14-day moving average around $1.2742 and around $1.2720, a July 9 high.

The currency is likely to consolidate around the current levels, as few traders will be eager to push it higher before the European Union unveils the stress tests on euro zone banks.

The euro has had a good run against the dollar in recent weeks, rising to a 10-week high above $1.30 on Tuesday as traders began to bet most of the 91 European banks being examined would pass the tests.

European policy makers have expressed confidence their banks will pass, although some analysts say investors remain sceptical about the severity of the checks.

Major listed banks, which face constant investor scrutiny, are expected to pass, but the tests may show the worst problems lie with smaller players such as Spanish cajas and German landesbanks, which are mainly unlisted.

Euro/dollar 1-month risk reversal EUR1MRR=ICAP, a measure of currency sentiment, showed a slight bias for euro puts.

Traders said that was partly reflecting some fears among players that the euro may start falling after the euro zone bank stress test results.

Data from broker ICAP EURVOL=ICAP shows euro/dlr 1-mth risk reversal standing at 1.25/1.75%, its highest since early July. (Additional reporting by Rika Otsuka; Editing by Michael Watson)