The yen fell and high-yielding currencies rose on Wednesday as growing expectations of a U.S. rate cut to ease tight liquidity conditions instilled a sense of calm and prompted investors to reenter risky carry trades.

Sen. Christopher Dodd, chairman of the U.S. Senate Banking Committee, on Tuesday said Federal Reserve Chairman Ben Bernanke had told him the central bank will use all available tools necessary to quell recent volatility in financial markets arising from fears of a credit and liquidity freeze.

Investors interpreted that as a sign that, while there may be no imminent cut in benchmark interest rates, the Fed would lower its key federal funds rate from 5.25 percent if need be.

This boosted stocks, weighed on top-rated government bonds, depressed currency market volatility and tempted traders back into the carry trade -- selling the low-yielding yen for assets in higher-yielding currencies.

There's some short-term normalcy in the market, with macro guys putting on carry trades, although they could be covering shorts, said Matt Kassel, director of foreign exchange at ING Capital Markets in New York.

The market has basically priced in a 50-basis-point rate cut. If that doesn't happen you're going to see some funding problems resurface, he added.

In early New York trading, the dollar was up 0.7 percent on the day at 115.16 yen, continuing to rebound from the 14-month low of around 111.60 yen last week.

The euro rose 0.8 percent against the yen to 155.29 yen and was up 0.1 percent against the dollar at $1.3476.

The Australian dollar was up 1.4 percent against the yen at 92.83 yen and the New Zealand dollar rose 1.3 percent to 80.59 yen.

Still, confidence in global credit markets has by no means been fully restored and fears persist that short-term liquidity will remain tight.

Markets are fairly quiet at the moment but there is a sense of anticipation; it may be that we are in the eye of the storm rather than the storm having passed, said Laura Ambroseno, currency strategist at Morgan Stanley in London.

In Japan, widespread expectations its central bank will keep interest rates on hold at 0.5 percent on Thursday also weighed on the yen, analysts said.

A month ago most market participants expected a 25 basis point rate hike at the end of this Bank of Japan meeting.

We think the BoJ will hold rates steady this month to allow time for current problems to play themselves out. How long this will take is the million-dollar question, said Bear Stearns in its latest research note.

Analysts said the nervousness in financial markets is likely to persist for some time, particularly with investors wary of taking on risk as conditions in the commercial paper markets, a critical source of short-term funding, remain tight given persistent turmoil in the U.S. subprime mortgage sector.

Yields on three-month U.S. Treasury bills, a reflection of investors' demand for safety, rebounded on Wednesday to 3.75 percent from a low of 2.9 percent on Tuesday.

U.S. rates futures are still reflecting perceived chances of almost 75 basis points of easing this year.

(Additional reporting by Jamie McGeever in London)