The yen strengthened across the board on Friday as global equity markets sagged on renewed fears that the U.S. financial sector may suffer even more losses, diminishing investors' risk appetite.
Investors were less willing to hold relatively risky carry trades in which cheap borrowing in the yen and Swiss franc funds purchases of high-yielding currencies.
Market participants bought the yen after the New York Times reported Merrill Lynch was expected to suffer $15 billion in losses from soured mortgage investments and that it was trying to raise capital from an outside investor.
As a result, Asian equities fell overnight, European stocks hit their lowest level in more than a year, and Wall Street posted steep losses.
"The yen is so tightly correlated with equity markets," said Greg Salvaggio, senior vice president of capital markets at Tempus Consulting in Washington.
"Obviously, there is still considerable concern and worry in the market about the extent of subprime mortgage exposure by U.S. financials. The news on Merrill Lynch showed there is still continued distress in this sector," he added.
In late morning New York trading, the dollar was down against the yen . The euro also dropped versus the yen, down about half a percent.
A report that the U.S. trade deficit widened more than expected in November, to $63.1 billion, dragged the dollar lower against the yen, although investors remained focused on developments in the financial sector.
The euro rose to a fresh record high versus sterling.
Sterling dipped to a 10-month low against the dollar as weak industrial output data confirmed investor expectations that the Bank of England would cut rates next month after leaving them at 5.50 percent on Thursday.
The low-yielding Swiss franc rallied to 1-1/2 month highs versus the dollar and five-month peaks against the euro, though it subsequently retreated a little.
The euro was down against the dollar, slipping following sharp gains the previous session.
The dollar tumbled against the euro Thursday as comments by Federal Reserve Chairman Ben Bernanke suggested an aggressive half-percentage point rate cut at its meeting on interest rates later in the month.
Many analysts welcomed Bernanke's dovish stance, noting that a sharp easing of interest rates could prevent the U.S. economy from sliding into recession.
"If the Fed continues to act in a decisive and timely way as promised, then the doom and gloom scenario could get scotched," said Bear Stearns in its latest research note.
"There should be some light at the end of the tunnel for the markets," it added.
The rate futures market has now fully priced in a 50 basis point cut in the fed funds rate to 3.75 percent, and also an 8 percent chance the Fed could lower rates by 75 basis points.