The dollar rose sharply versus the yen on Monday, bolstered by stronger-than-forecast Japanese data and a Standard & Poor's upgrade to the credit outlook for the United States government.
The greenback earlier found support after Japanese equities closed almost 5 percent up on the day, and gains accelerated in early New York trade after S&P changed the credit outlook of the U.S. to "stable" from "negative."
Japan's economy grew at a much quicker pace in the first quarter than had been previously estimated, an encouraging sign for that government's aggressive plan to boost growth.
The dollar was boosted by an upward revision to Japanese first-quarter growth, lifting Japanese equities, which typically causes the yen to fall.
"The correlation between the world's current two most crowded trades—dollar/yen and the Nikkei—remains intact, with positioning short the yen and long the Tokyo bourse," said Dean Popplewell, chief currency strategist at OANDA in Toronto.
S&P meanwhile said the chances of a U.S. ratings downgrade is now "less than one in three" as improvements in tax receipts and economic performance are helping to bring down the country's debt levels.
"The revised rating is positive news for the dollar, but I do not see it being a major catalyst. This is just the latest indication that we are seeing a broad stabilization and improvement in the economy," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington.
The dollar hit a session high of 99.28 yen and last traded up 1.1 percent at 98.64 yen, significantly above Friday's trough of 95.02 yen, which marked its lowest since the Bank of Japan unveiled aggressive monetary easing on April 4. Traders reported offers up to 99.50 yen but bids around 98.00 yen.
The euro also rallied against the yen to last trade up 1.3 percent at 130.74 yen.
The last three-weeks has delivered a strong increase in Japanese repatriation flows, driven mostly by banks in April and May, while life insurance companies also returned to repatriation in May after accumulating foreign assets in April, according to Popplewell.
"The current market squeeze is making it more expensive for the speculator to reestablish their short yen positions. The yen bears have been playing catch up ever since they pared last week's positions," he said.
The dollar, however, pared gains in mid-morning New York trade after a top Federal Reserve official said low U.S. inflation means the Fed can stick to its aggressive bond buying campaign if it decides that it is warranted.
The Fed's asset purchase program, called quantitative easing, is seen as negative for the dollar as it is tantamount to printing money. Investors have recently been selling the dollar on expectations the Fed will keep its $85 billion per month bond buying program intact.
The dollar last week saw its worst weekly performance against the yen since mid-2010, but strategists said further losses would be limited as dips in the pair were still considered good buying opportunities.
"Last week with elevated nerves about what Fed tapering means and when it could start, we saw this knee-jerk rush to safe havens like the yen," said Sara Yates, global head of FX strategy at JP Morgan Private Bank. "I think what we are seeing at the moment in the market is the unwinding of that."
Yates said that while in the near term there was scope for more volatility in dollar/yen, the dollar is forecast to rise to 105 yen in 12 months, given the BOJ's aggressive stimulus plan and as talk about how and when the Fed may slow its pace of asset purchases gains momentum.
(Read More: Japan Revises First Quarter Growth Figures Upwards)
The dollar on Friday recovered from heavy losses against the yen after data showed that U.S. employers had added a slightly above-forecast 175,000 jobs in May.
But analysts said this did not point to a sustained recovery in the economy, and the dollar remained vulnerable to weak U.S. data.
"(The jobs data) hasn't changed the market's view much on the timing of Fed tapering," said Kasper Kirkegaard, currency strategist at Danske Bank, adding that the dollar was likely to react more to weaker rather than stronger U.S. data because the market still held hefty bets of dollar gains.
Markets will focus on the Bank of Japan's two-day policy meeting that ends on Tuesday for Gov. Haruhiko Kuroda to address the recent market volatility. Analysts said it was unlikely the central bank will announce any decisive measures.
Meanwhile, the euro erased earlier losses versus the dollar and hit a session high as European stocks ended slightly lower on China's unexpectedly weak import data.