The yen fell across the board on Thursday, hitting a seven-week low against the euro, as traders bet Japan's upper house elections on Sunday would strengthen Prime Minister Shinzo Abe's position and his stimulus plans.
Opinion polls show Abe's ruling bloc on track for a big win, which will give Abe more freedom to push forward his agenda to revive the economy through aggressive monetary easing and hefty government spending.
(Read more: Fate of yen hinges on Japan's weekend elections)
The monetary easing would lower bond yields and spur Japanese investors to buy higher-yielding overseas assets by selling the yen.
The dollar and euro have gained about 15 percent against the yen so far this year on expectations of aggressive easing in Japan. But the rally has lost momentum since the dollar hit a 4 1/2-year high of 103.73 yen in late May.
"Japanese elections over the weekend should encourage more outflows out of Japan," said Sebastien Galy, foreign exchange strategist at Societe Generale in New York.
The dollar gained 0.9 percent to 100.44 yen, having reached a session peak of 100.65 yen, according to Reuters data.
Hedge funds were cited as buyers of dollar/yen with stop-loss buy orders layered at 100.50 and 101.00 yen, traders said.
The Japanese yen is the worst performing of the world's 36 most actively traded currencies against the dollar in the last year, according to Reuters data. Some US$2.6 billion in yen changed hands on Thursday.
The euro rose as high as 131.88 yen, the strongest since May, before pulling back to 131.66 yen, up 0.8 percent.
"Anything that will strengthen Abe's position will be positive for the Nikkei and dollar/yen," said Beat Siegenthaler, currency strategist at UBS. "The yen has not been the focus of late, but this could embolden investors and have the potential to trigger weakness."
Morgan Stanley said in a note that a break above 101.55 yen for dollar/yen could signal a return to the upward trend.
The dollar held on to broad gains as investors bet U.S. economic data would support plans by the Federal Reserve to move away from ultra-loose monetary policy soon.
Data on Thursday showed new claims for U.S. jobless benefits fell last week and factory activity picked up in the mid-Atlantic region in early July, signs of a stronger economy that could help push the Fed to ease its monetary stimulus.
The euro fell 0.1 percent to $1.3107.
"We are bullish dollar but we are getting mixed signals from the Fed," said Peter Kinsella, currency strategist at Commerzbank. "Fed tapering will be very data-dependent and if we get good jobs data next month, then we can expect stimulus withdrawal by September. Otherwise, expectations of tapering will be pushed back to December. This uncertainty should keep it rangebound."
The dollar had been boosted by higher U.S. yields but doubts over when the Fed will start withdrawing stimulus have kept it clear of three-year highs on July 9.
In congressional testimony on Wednesday, Fed Chairman Ben Bernanke said the central bank still expected to start scaling back its bond-purchase program later this year but left open the option of altering that plan if the economic outlook changed.
(Read More: Bernanke: Too early to tell when tapering will start)
In his second day of Congressional testimony, Bernanke reiterated that the Fed intends to maintain a highly accommodative policy for the foreseeable future.
"Although Mr. Bernanke refrained from giving further details on the exit strategy, the FOMC may have little choice but to switch gears ahead of schedule as the committee anticipates a stronger recovery in the second-half of 2013, and the central bank may find it increasingly difficult to preserve its highly accommodative policy stance as the economic recovery gathers pace," said David Song, currency analyst at DailyFX in New York.