The dollar edged lower against the yen on Tuesday after China said it would raise a stamp duty on stocks in an attempt to cool its equity markets, prompting concerns about risky trades financed by borrowing in the Japanese currency.
The euro dropped against the yen, after touching an all-time high, and U.S. stocks fell on expectations the move by China may prompt further losses in global equity markets and heighten risk aversion.
China's move "is a clear attempt to restrain the equity boom," Alan Ruskin, chief international strategist with Greenwich Capital Markets in Greenwich, Connecticut, said in a note. "The market remains extremely sensitive to all things China, and there has been some sell-off in U.S. equities and the likes of euro/yen on the back of the latest news.
"This is likely to cause at least a few flutters in the Chinese equity market tomorrow," he added.
The euro was trading , relatively unchanged on the day, after rising to one-week highs around $1.3520.
The euro traded lower against the yen after rising to a record high of 164.28 yen earlier, according to electronic trading platform EBS. The dollar also edged lower against the yen .
Chinese authorities raised the stamp duty on share trades to 0.3% from 0.1% starting on Wednesday. In the 16-year history of the modern Chinese stock market, an increase in stamp duty has always caused a market slump over the following few weeks.
"It's a risk aversion play. The move could lead to an unwinding of carry trades," said Ron Simpson, director for currency research at Action Economics in Tampa, Florida. "This is basically the same thing that sparked yen buying in February when the Chinese stock market got smashed."
In carry trades, investors borrow low-yielding currencies like the Japanese yen to fund purchases of assets offering higher returns.
Before China's announcement, the greenback traded lower against the euro for most of the session as comments by European Central Bank officials suggesting more euro-zone rate increases prompted investors to sell the dollar after recent gains.
Still, some analysts believe the pullback earlier in the dollar was temporary given the relative lack of fresh economic news. Investors now may focus on the minutes of the Fed's last rate-setting meeting, due on Wednesday, and the release of the second estimate of first-quarter growth data on Thursday.
The monthly payrolls report for May is due on Friday.
Investors "appear to be cautious ahead of the major U.S. data due out later this week, with market moving potential" said Michael Woolfolk, a senior currency strategist at The Bank of New York. "With U.S. data consistently surprising on the upside recently, it is likely that dollar bulls find a catalyst to continue buying."
The dollar got some support on Tuesday after a U.S. consumer confidence report for May showed a higher inflation outlook for the next 12 months, diminishing expectations for interest rate cuts by the Federal Reserve.
The Fed is considered more likely to raise interest rates when inflation is higher, making dollar-denominated investments more attractive.
The day's biggest mover was the Canadian dollar , which rose to a fresh 29-1/2-year high against the greenback at around C$1.0710. The Bank of Canada held its key overnight interest rate unchanged at 4.25%, as expected, but said a near-term rate hike may be needed to tame inflation.