The yen gained broadly Monday as investors cut exposure to risky carry trades amid expectations of widening financial sector losses tied to the U.S. subprime mortgage market.
The latest casualties outside the United States include four Norwegian municipalities hit by losses on U.S. investments and German state-backed regional lender WestLB, which will see a loss of up to 1 billion euros this year, thanks in part to the global credit market crisis
In addition, some analysts have forecast that Royal Bank of Scotland will announce up to 1.9 billion pounds ($4.13 billion) of credit-related losses this week.
Traders also pointed to a report by Moody's Investors Service on Friday that it may be preparing a series of credit-rating cuts related to subprime mortgages that may impact over $100 billion worth of securities.
"Between the Moody's report and news of more casualties in the financial markets, investors are simply going safe at the start of the week by buying yen," said Greg Salvaggio, a senior currency trader at Tempus Consulting in Washington.
Investors often borrow low-yielding yen to invest in higher-yielding, more risky securities and reverse those trades when risk aversion rises, bolstering the yen.
Salvaggio said the Japanese currency may rebound to 107 yen per dollar by the end of the year.
The dollar was down 0.7 percent at 110.37 yen having risen on Friday to 111.23, its highest level since mid-November. The euro was down 0.5 percent at 161.81 yen .
The dollar briefly pared losses against the yen after U.S. Treasury Secretary Henry Paulson said the government is close to brokering a comprehensive mortgage aid plan that will shepherd many troubled subprime borrowers into safe and sustainable loans.
The European currency rose 0.2 percent to $1.4665, still about 3 cents below November's record peaks but recovering some ground after posting its biggest weekly percentage fall in more than three months.
A report showing U.S. manufacturing growth slipped in November had little impact on the U.S. dollar.
"The market is increasingly concerned ... that the subprime and credit issues within the U.S. have now an increasing possibility to spill out into a global event and have a bigger impact on the global growth outlook," said Ian Stannard, senior foreign exchange strategist at BNP Paribas."
"In this environment we would expect the low yielders topick up some support," he added.
Last week, the dollar rose 1.5 percent against a basket of currencies -- its biggest weekly gain since June 2006 -- after comments by top Federal Reserve officials cemented expectations for interest rate cuts next week and more next year.
The expected rate cuts boosted confidence that the Fed would keep the U.S. economy from recession, igniting gains in stock markets.
On Monday, the dollar index traded 0.2 percent lower at 75.977.
Markets are fully priced for a 25 basis point cut in the Fed's benchmark interest rate to 4.25 percent when the Federal Open Market Committee concludes its two-day policy-setting meeting on Dec. 11 and are giving as much as a two-in-five chance of a bigger 50 basis points move .
Investors were reluctant to take big risks before euro zone and British interest rate decisions this week and a closely watched U.S. employment report that may help determine the extent of U.S. monetary policy easing next week and in the new year.
The European Central Bank is expected to hold its key rate at 4 percent on Thursday.
Growth in the U.S. factory activity slipped in November for the fifth straight month. The Institute for Supply Management said its index of national activity edged down 50.8 in November from 50.9 in the previous month.
"The ISM number doesn't really add much to anything so that's why we had a pretty muted dollar reaction," said Shaun Osborne, chief currency strategist at TD Securities in Toronto. "The bias is still for the Fed to lower rates."