The yen rose across the board on Wednesday as falling European stocks encouraged investors to reduce exposure to risky assets and unwind carry trades despite the Federal Reserve's hefty interest rate cut.
The Fed's 75 basis point reduction of its benchmark overnight lending rate to 3.5 percent on Tuesday did little to calm investors' fears of a U.S. recession and its impact on the global economy, analysts said.
Moves in stock markets are regarded as a barometer of investors' appetite for risky carry trades, which involve borrowing in the low-yielding yen to buy higher-yielding currencies and assets.
European stocks fell sharply on concerns over bank writedowns and earnings downgrades, while U.S. stock index futures pointed to another lower open on Wall Street.
"Despite the Fed's move yesterday there is still a great desire to reduce risk and the way that works in foreign currency markets is to buy low yielding currencies," said Marc Chandler, senior currency strategist at Brown Brothers Harriman in New York.
"The currency markets continue to be dominated by risk aversion ... people buying the yen, Swiss franc and the dollar."
In morning New York trade, the dollar was down against the yen, not far from a session low of 104.98 and its lowest level since May 2005, according to Reuters data. The euro dropped versus the Japanese currency, while the dollar slipped against the Swiss franc.
Low yielding currencies such as the yen and Swiss franc tend to attract flows during periods of uncertainty as the low interest rates reflect the capital surplus of their respective countries.
The euro was also hurt after euro zone services sector growth fell below forecasts to a rate not seen in over four years, adding to the case for an interest rate cut from the European Central Bank.
Euro zone interest rate futures now expect around 75 basis points of ECB easing this year from their current 4 percent level, with the first rate cut expected before June. Futures at the start of January pointed to the ECB being on hold all year.
The euro was down against the dollar.
"The key question for the dollar now is whether other central banks will follow the Fed's aggressive easing lead, as they did in 2001," said strategists at UBS in a note.
"We believe the Fed's inter-meeting move lends credibility to our view that G7 decoupling will prove elusive. And we think the ECB will have to follow the Fed sooner rather than later."
The high yielding Australian dollar fell against the U.S. dollar, despite a report showing that core inflation rose at its fastest pace in 16 years last quarter.
The New Zealand dollar tumbled against the greenback.