The yen dropped to a two-month low against the dollar on Wednesday as speculators and investors took data showing Japan had logged its first annual trade deficit since 1980 as a cue to unwind bullish bets on the Japanese currency.

The euro fell from session highs against the dollar and a one-month high versus the yen as worries the European Central Bank would need to take losses on its Greek bond holdings outweighed a strong German business sentiment survey.

The focus was shifting to the Federal Reserve, which is expected to begin a new practice of announcing individual policymakers' interest rate projections later.

Economists expect the U.S. central bank will signal it is unlikely to start hiking interest rates until the first half of 2014, over five years after cutting near to zero.

U.S. yields have pushed up in recent days and if data there continues to improve we would see the dollar supported, said Geoff Kendrick, currency strategist at Nomura.

But the risk is the Fed could be more dovish than what the market is expecting, in which case you might see the dollar pull back. In any case, I do not see the dollar rising to 80 yen.

The dollar reached as high as 78.244 yen on trading platform EBS, its highest since late November. Selling in the yen picked up after Japan logged an annual trade deficit in 2011 for the first time in over 30 years.

Traders cited robust offers from Japanese exporters up to 79 yen, while the options market showed dollar/yen risk reversals skewed towards dollar calls out to the 6-month tenor, hinting at more dollar gains. The one-month traded at levels last seen in 2003 at 0.8 for dollar calls.

Lee Hardman, currency economist at Bank of Tokyo Mitsubishi UFJ was skeptical the trade deficit would have a lasting impact on the yen.

With Japan running a sizeable and more stable investment income surplus totaling close to 15 trillion yen in the twelve months to November 2011 its current account balance has remained firmly in surplus, he said. Recent yen weakness is more likely corrective than a trend reversal. The Fed's commitment to maintain low rates will help cap dollar/yen upside potential.

Chartists highlighted resistance posed by the 200-day moving average at 78.33 yen and the 61.8 percent retracement of the October-January fall at 78.31 yen.


The broad weakness in the yen lifted the euro to a four-week peak of 101.88 yen. It was last trading at 101.22 yen, flat on the day, but well above its 11-year low of 97.04 struck on January 16.

The euro gave up gains against the dollar made immediately after the German Ifo survey as growing worries that the European Central Bank would have to write down its holdings of Greek debt, crimping its ability to purchase other periphery debt, drove Italian yields higher.

Uncertainty over the Greek debt talks and disappointment that there has still been no deal is spoiling the party for the euro, said Audrey Childe-Freeman, EMEA head of currency strategy at JP Morgan Private Bank.

So despite the good IFO numbers, the euro is not able to break past $1.3080 which is a good resistance level.

The single currency was last trading down 0.5 percent for the day at $1.2956, off a session high of $1.3052. It struck a three-week peak of $1.3063 on Tuesday, with resistance $1.3075-1.3080 area - highs struck earlier this month and in late December.

The common currency has been supported against the dollar in recent sessions by a squeeze in extreme short positions. A decline in funding costs for Spain and Italy and recent data that have showed a surprising strength in manufacturing and services this month have also lent support.

Portugal also eased market jitters after its prime minister said the country was not seeking to renegotiate or extend its 78 billion euro bailout package.