The yen's three-day rally fizzled out on Thursday as a rebound in stocks eased concerns about the U.S. high-risk mortgage market and prompted investors to borrow the Japanese currency again to fund carry trades.
The dollar steadied versus the euro, with markets awaiting the outcome of a two-day Federal Reserve meeting later in the session. The bank is seen holding rates at 5.25 percent and its statement will be scrutinized for clues on future policy.
Softer U.S. data this week had shifted investor sentiment back towards the next Fed move being a cut rather than a hike, although most see rates on hold for the rest of the year.
The Nikkei share average closed 0.46 percent higher on Thursday and European shares jumped 0.9 percent after gains on Wall Street overnight, signaling a revival of risk appetite.
The Australian and New Zealand dollars jumped against the yen as investors moved back into carry trades, in which low-yielding currencies are borrowed to fund higher-return investments.
Yesterday it looked like the correction to carry trades was finally getting under way in currency markets with support from both rate and equity markets -- particularly equity markets which were looking somewhat gloomy, said Teis Knuthsen, head of FX research at Danske Markets in Copenhagen.
Now it seems we're back to square one -- all that is carrying a high interest rate is rallying against those with a low interest rate. Carry is back, he added.
By 0946 GMT the dollar was up 0.2 percent at 123.09 yen, recovering from a two-week low of 122.21 hit in the previous session according to Reuters data.
The euro was up 0.3 percent at 165.76 yen, edging back towards last week's record high at 166.95 yen, and little changed from late New York trade at $1.3463.
Euro zone M3 money supply growth accelerated in May while loans to the private sector held steady, data showed.
Federal Reserve policy-makers will end their meeting on Thursday, and investors widely expect them to leave rates unchanged and maintain their stand of curbing elevated inflationary pressures.
We expect ... the statement to acknowledge better growth data and remain benign with regards to inflation risks. Such a result would signal a bias for the Fed to remain on hold and should be supportive of general risk appetites and FX carry trades, JP Morgan said in a research note.
HIGH YIELDERS RALLY
The yen had rebounded from multi-year lows versus major currencies this week after risk appetite was dented by falling equities, rising global volatility and worries that problems in the U.S. subprime loan market could start to hurt the broader economy.
The yen's gains were accentuated after Japanese, New Zealand and South Korean officials voiced concern about its weakness.
But a recovery in equity markets -- where energy stocks rallied on higher oil prices -- made investors more comfortable about selling the yen afresh on Thursday.
A surprise fall in Japan's industrial production data in May also weighed on the yen.
The higher-yielding New Zealand dollar gained the most against the yen, rising 0.9 percent to 94.26 yen, crawling back towards a 20-year high hit late last week.
The Australian dollar climbed 1 percent to 103.92 yen, moving towards a 16-year peak hit last week.