Data showing that Japan's economic growth slowed markedly in April-June helped drag Tokyo shares lower. The dip in equities gave support to the yen, which is a funding currency for carry trades and tends to rise in times of market stress.
A fall in the 10-year U.S. Treasury yield to a fresh 16-month low on Monday was one factor weighing on the dollar against the yen, due to the high recent correlation between dollar/yen and Treasury yields.
The yen was also bolstered by talk of yen-buying by Japanese exporters and market speculation about possible fund repatriation by Japanese investors related to coupon payments on U.S. Treasuries due around now.
I think the basic direction is toward dollar weakness and yen strength, said a trader for a major Japanese bank.
But the yen's gains were tempered by caution ahead of a possible meeting between Prime Minister Naoto Kan and Bank of Japan Governor Masaaki Shirakawa later this week to discuss the currency's strength and possible responses.
The dollar dipped 0.4 percent against the yen to 85.83 yen, slipping back in the direction of a 15-year low of 84.72 yen struck on trading platform EBS last week.
Traders said there was a decent amount of bids in dollar/yen on the downside, all the way down to around 84.50 yen, and such bids were likely to support the dollar.
The New Zealand dollar fell 0.7 percent against the yen to 60.43 yen and the Australian dollar slipped 0.6 percent to 76.44 yen, while MSCI's broad measure of Asian shares outside Japan shed 0.3 percent.
The euro dipped 0.1 percent against the yen to 109.81 yen, having earlier dropped as low as 109.25 yen on trading platform EBS.
Daily Ichimoku charts are now flashing a sell signal for the euro against the yen, with the euro having dropped below the cloud and into bearish territory.
The euro edged up 0.3 percent against the dollar to $1.2795, having pared its losses after dipping to $1.2734 on trading platform EBS earlier on Monday, its lowest against the dollar in almost a month.
Last week, the yield spreads between government bonds issued by peripheral euro zone countries and German bonds widened due to concerns over the cost of supporting the Irish banking sector and a lackluster debt auction in Italy.
Some traders said Japan's weaker Q2 GDP data could increase incentives for Japanese authorities to take measures to curb export-sapping yen strength.
Government sources have said it and the BOJ are coordinating to set up a meeting between Kan and Shirakawa that is likely to be in the second half of this week, and that has stirred market speculation that Japanese authorities may soon unveil some type of response on the yen.
Economics Minister Satoshi Arai said on Monday the government was in discussions with the BOJ on the yen's rise. Arai added, however, that he was unaware if Kan would meet Shirakawa soon.
Market players say the most likely possibility is the adoption of some form of additional monetary easing or liquidity provision steps such as expanding the amount or duration of the BOJ's fixed-rate fund supply operation, and yen-selling intervention seems unlikely at this stage.
Analysts at RBC Capital Markets see a relatively small risk of outright intervention by the Japanese authorities.
The yen is not particularly high in real terms, given that Japan has been in deflation for several years, they said.
Also, the declining share of the U.S. in Japan's trade and the rise of China diminishes the importance of the dollar to the Japanese authorities, so long as China delivers the yuan flexibility it promises, RBC said in a note to clients.
If Japan were to intervene, market players say the general feeling is that the rest of the Group of Seven nations would not support intervention, leaving Japan to go it alone.
(Additional reporting by Wayne Cole in Sydney and Kaori Kaneko and Shinji Kitamura in Tokyo; Editing by Michael Watson)