Yen up as investors position ahead of Japanese election

Sha Ying | CNBC

The dollar slipped against the yen in late trade on Friday ahead of elections for Japan's upper house Sunday which could add momentum to Prime Minister Shinzo Abe's aggressive push for monetary easing to lift growth and fight deflation.

Earlier the dollar held near a one-week high against the yen but as trading slowed ahead of the weekend, the U.S. currency gave up gains.

Opinion polls show Abe's ruling Liberal Democratic Party and its New Komeito Party coalition partner are on track to win a hefty majority this Sunday. That would give him more freedom to push his agenda of monetary easing, public spending and structural reform, which could weigh on the yen.

"What appears to be clear, barring any sharp surprises in the outcome, is that Mr. Abe is likely to consolidate his power and maintain course for an accommodative fiscal and monetary policy," said Boris Schlossberg, managing director of FX Strategy at BK Asset Management in New York.

"That in turn should prove to be dollar/yen bullish unless the (Japanese government bond) market in Japan turns volatile once again," he added.

The dollar hit a one-week high of 100.86 yen, according to Reuters data, before pulling back slightly to 100.31 yen, or down 0.1 percent on the day. Resistance was cited at the July 8 high of 101.53 yen. The dollar is up more than 15 percent against the yen so far this year.

The euro rose 0.2 percent to $1.3139, while the dollar index was down 0.3 percent at 82.585, above Wednesday's three-week low of 82.342.

Some US$2.3 billion in yen changed hands on Friday, and US$3.5 billion in euros, using Reuters Dealing data.

The dollar has gained 1 percent this week against the yen, while the euro has advanced 0.6 percent against the dollar, its second straight week of gains.

Earlier in the session, the yen strengthened after Japan's benchmark Nikkei stock averageslipped. A fall in equities can increase risk aversion and spark demand for the yen, a traditional safe-haven currency.

But analysts said the yen remained vulnerable to the Bank of Japan's massive monetary expansion, while the dollar has been supported by prospects that the U.S. Federal Reserve could start scaling back its stimulus.

"We should see the USDJPY maintain the upward trend from earlier this year amid the growing discussion at the Federal Reserve to taper the asset-purchase program, and we will look to buy dips in the exchange rate amid the deviation in the policy outlook," said David Song, currency analyst at DailyFX in New York.

While the options market has been showing demand for dollar/yen puts, or bets the dollar will lose ground, one-month risk reversals have narrowed to around 1.1 vols in favor of dollar puts on Friday from 1.75 vols on July 11, indicating market players have trimmed their yen strength bets.

Chris Turner, head of FX strategy at ING, said any strength in the yen would be temporary and risk reversals suggest markets are slightly less concerned about a big correction lower in dollar/yen.

"The focus is very much on beating deflation over the next two years, and the Bank of Japan is committed to doubling its balance sheet by the end of 2014," he said, which will involve pumping yen into the market.

Some strategists also cautioned that with expectations so high, if Abe does not manage to win a landslide victory, there was an outside chance this could lift the yen.

"It could put a question mark on Abe's policies and be yen positive," said Niels Christensen, FX strategist at Nordea.

The Australian dollar rose after China's central bank announced long-awaited interest rate reforms, a move it said would help lower financing costs for companies. China is a major export destination for Australia.

The Australian dollar rose 0.3 percent to $0.9191.

China's central bank announced on Friday that it was removing the floor on lending rates for commercial banks, meaning that banks will now be able to cut rates as much as they see fit to attract borrowers