The yen weakened broadly on Wednesday as traders took Japan's new monetary policy measures unveiled the previous day as a cue to sell, while mixed signals from stocks and commodities kept the dollar in check.
Receding fears over Dubai's debt problems and the prospect of U.S. interest rates staying low for some time weighed on the dollar, but talk of Asian central banks buying and the greenback's gains against the yen offered broad support.
The dollar has been widely considered the funding currency of choice in recent months as investors have sold the low-yielding unit for other currencies and assets. But the Bank of Japan's new measures have put that spotlight back on the yen.
Its new liquidity measures to combat deflation and keep short-term rates down prompted position squaring and profit taking from investors betting on a stronger yen.
The euro was well supported ahead of the European Central Bank's policy meeting on Thursday. The bank is expected to announce details on how and when it will remove liquidity from the system, and could upgrade its growth forecasts.
We had very strong yen appreciation (recently), and now there's some retracement. Risk appetite is a little bit stronger than it was last week when we had the Dubai news, so investors are taking profits, said Marcus Hettinger, FX strategist at Credit Suisse in Zurich.
The BOJ didn't really do anything (major), but the risk is higher now of intervention, he said, adding the dollar could rise to 90 yen if stocks make further gains.
At 1100 GMT the dollar stood at 87.30 yen, up 0.7 percent on the day. Traders said a break above 87.50 yen would trigger pre-placed buy orders and herald a stronger push higher.
The euro was up almost 1 percent at 131.90 yen EURJPY= and up 0.1 percent against the dollar at $1.5105, after gaining 1 percent and 0.5 percent respectively the previous day.
The single currency was near a recent 16-month high of $1.5145 set on trading platform EBS, with strong trendline support seen at $1.4900 and then at $1.4860.
The dollar index, a measure of its strength against a basket of six currencies, was flat on the day at 74.39, not far above last week's 16-month low of 74.17. Asian stocks closed higher but European bourses and U.S. futures were mixed. There was also some divergence in the commodities sphere, with gold hitting new highs at $1,216.75 an ounce XAU= but oil down 0.7 percent CLc1.
The BOJ said after an emergency meeting on Tuesday it would provide 10 trillion yen ($115 billion) in three-month funds at a fixed rate of 0.1 percent, relieving government pressure to act against deflation and avert another recession..
The dollar hit a 14-year low of 84.82 yen last week as concerns over debt problems in Dubai saw investors unwind risk trades funded by the yen, pushing the Japanese currency up.
Tuesday's decision was seen as a way to avoid a return to a narrow form of quantitative easing, under which the BOJ slashed rates to zero and flooded markets with cash in 2001-06.
Prime Minister Yukio Hatoyama was quoted as saying on Tuesday the yen's rise could not be left as is, Nikkei said, but a spokesman later said Hatoyama was not talking about currency intervention.
The measures yesterday are a disappointment. It's more of a monetary policy tool, but if in the process it weakens the yen it will be a good thing for some in Japan, said Neil Jones, head of FX hedge fund sales at Mizuho in London.
The big selling flows in dollar/yen and cross/yen last week are drying up somewhat, Jones said, noting good Japanese importer demand for dollars and other currencies and Japanese retail investors buying higher-yielding foreign assets.
Markets will be watching U.S. data later, ahead of monthly jobs numbers due on Friday. A November employment report by Automatic Data Processing at 1315 GMT is expected to show 155,000 jobs lost in the month after 203,000 lost in October.