The dollar rose against the yen on Thursday, reversing the prior day's losses, after data revision showed the U.S. economy grew at a faster pace in the fourth quarter of 2007 than initially reported.
Investors have also reentered risky carry trades, which involve borrowing the low-yielding yen to fund purchases of other assets with higher interest rates such as the Australian and New Zealand dollars.
The gross domestic product report, meanwhile, showed the U.S. economy may be more resilient than many initially thought and supported growing expectations the Federal Reserve may hold interest rates steady for some time and not cut them.
"Dollar/yen is increasingly proving to be the pair most sensitive to U.S. data," said Ashraf Laidi, chief currency strategist, at CMC Markets in New York.
But the big story was the return of the market's risk appetite, traders and analysts said.
That was partly fueled by statements from Fed Chairman Ben Bernanke on Wednesday when he gave a more balanced view of the U.S. economy, some analysts said. Bernanke acknowledged risks from the weak housing market, but also stressed lingering inflationary pressures.
The markets interpreted that to mean the Fed is not ready to reduce U.S. interest rates just yet.
"Risk appetite has picked up in the last 24 hours," said Tim Mazanec, director of foreign exchange with Investors Bank & Trust in Boston. The trigger "may have been Bernanke going back to saying inflation remains elevated."
Investors are also more confident that geopolitical tensions between Iran and the United States will not escalate into a full-blown confrontation.
The U.S. government on Thursday said it remains committed to pursuing a diplomatic resolution of tension in the Middle East, which analysts said calmed investors as they await the next monetary policy move from the Fed.
"The markets are taking the Iran story in stride, despite the rise in oil prices, while largely focusing on the next step from the Fed now that it has affirmed the hawkish aspect of its policy directive,"said CMC's Laidi.
Minneapolis Federal Reserve President Gary Stern on Thursday echoed Bernanke's moderately hawkish tone, saying the U.S. economy is "anything but fragile" and that the worst of the housing market crunch might be over.
Kathy Lien, chief fundamental analyst at DailyFX.com, said given Thursday's generally solid GDP report, "markets are pushing out expectations of a Fed rate cut. She added that chances of an August rate easing seemed to be diminishing as well.
The New Zealand dollar -- which enjoys the highest interest rates in the industrialized world at 7.5% compared with just 0.5% in Japan -- climbed , easily erasing the previous day's slide. At current prices, it was the biggest one-day percentage gain in the pair since March 9, according to Reuters data.
The Australian dollar also posted steep gains, the pair's biggest one-day percentage gain since March 19.