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Dollar Rallies vs. Yen Ahead of BOJ Meeting

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The dollar rallied from one-month lows against the yen on Tuesday, benefiting from a rally in U.S. stocks and investor caution on the Japanese currency ahead of a Bank of Japan monetary policy meeting this week.

The BOJ is widely expected to ramp up its bond buying and extend the maturities of the bonds it purchases under new Governor Haruhiko Kuroda at the bank's April 3-4 policy gathering. The yen, however, had rallied over the holiday weekend after recent losses and investors have used its rise to cash in on gains.

(Read More: Will Japan's Central Bank Deliver or Disappoint?)

"It's a bit of a give-back for the yen after its rally over the weekend, and now the market is anticipating what the BOJ would and won't do at this week's policy meeting," said Brian Dangerfield, currency strategist at RBS Securities in Stamford, Conn.

Gains in U.S. stocks have also boosted the dollar, analysts said, with the rolling 25-day correlation between the greenback and the S&P 500 at 44 percent. The two assets' correlation has risen steadily since March.

Traders, however, reported thin liquidity in major currencies as European markets reopened after the Easter holiday, and said price moves were expected to be subdued.

The dollar was last up 0.2 percent against the yen at 93.43 yen after earlier hitting 92.54 yen, its lowest since March 1.

The euro was last nearly flat on the day against the yen at 119.76 yen, up after hitting a five-week low of 119.10 yen. Chart support for the euro was seen at its late-February trough of 118.74 yen.

Euro on the Defensive

The euro, meanwhile, slipped against the dollar, pressured by euro zone data showing the region was well into economic contraction territory last month.

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This has prompted expectations European Central Bank President Mario Draghi would strike a more dovish tone at Thursday's monetary policy outlook meeting. He could also provide hints about a possible rate cut.

"The data does ... confirm that the outlook for the euro zone has deteriorated over the last month on almost all fronts, including economic, banking sector and EMU (European Monetary Union) perspectives," said Camilla Sutton, chief currency strategist at Scotiabank in Toronto.

(Read More: Euro Zone Factories Suffer, but No Cyprus Impact Yet: Survey)

"We expect euro zone fundamentals to deteriorate further—this combined with outflow pressures should keep the euro's downward trend intact," she said. Sutton expects the euro to close the year at the $1.25 level.

The euro was last down 0.2 percent against the dollar at $1.282, within sight of a four-month low of $1.2750 hit last week.

Euro zone purchasing managers' surveys added to concerns about the single currency's outlook by showing a deepening decline in manufacturing activity in March, with Italy and Spain particularly weak.

(Read More: Over 50% of Under 25s Remain Jobless in Greece, Spain)

Further weighing on the euro and its outlook was the resignation of Cyprus' finance minister after concluding a 10 billion euro bailout deal with international lenders in which the country slashed its dominant banking sector and hit depositors with losses.

Michael Sarris, a lead player in talks with International Monetary Fund and European Union lenders, said he had completed his task but also that he was likely to come under scrutiny in an investigation into the crisis.

Europe's common currency was expected to stay below chart resistance at the March 23 high around $1.3050, also due to concerns about Cyprus' bailout and possible ramifications for other indebted euro zone countries. Analysts have identified Slovenia as possibly the next euro zone candidate for a bailout.

"Through the Cypriot crisis, investors have been dealt a strong reminder that the euro zone crisis is alive and kicking despite the generous weight of liquidity that has been so effectively insulating investors from bad news in recent months," said Jane Foley, senior currency strategist, at Rabobank in London.

Investors were also cautious before Thursday's ECB meeting. Although interest rates are expected to be left on hold, analysts saw a small chance of a cut.

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