The yen rose broadly Tuesday, benefiting from mounting risk aversion as heightened fears of further losses in the banking sector and global stocks prompted investors to sell dollars.
Yen gains versus the dollar were limited as demand for the greenback rose after a report showed U.S. manufacturing activity expanded unexpectedly in June.
Risk aversion in currency markets was stoked by a slide in global stocks.
The yen tends to garner support in times of heightened risk aversion as investors reverse trades financed by borrowing the Japanese currency at low interest rates.
"In times of uncertainty and when stocks across the globe are tanking, investors buy yen -- it's that simple," said Andrew Busch, a global foreign exchange strategist at Bank of Montreal in Chicago.
In midday trading in New York, the dollar was lower against the yen while the euro slid versus the Japanese currency .
Implied one-month dollar/yen volatility was holding near one-month highs at 12.30 percent.
"Yen volatility has spiked higher and to us that is the worst kind of mix for selling the yen, that is higher volatility and lower yield differentials. And as long as that persists ... we continue to forecast the yen to strengthen to higher levels," said Derek Halpenny, senior currency strategist at BTM-UFJ in London.
The euro was last higher versus the dollar .
The European currency pared gains versus the greenback after the Institute for Supply Management said its index of national factory activity rose in June to 50.2 from 49.6 in May after four straight months of contraction.
"The dollar is likely to receive a modest boost from this morning's encouraging data," said Joe Manimbo a currency trader at Ruesch International in DC. "The ISM index climbed back into growth territory, and should ease some of the concerns about the outlook for the U.S. economy that had pressured the dollar overnight."
In contrast, data showed euro zone manufacturing activity contracted for the first time in three years in June and output prices matched April's year high.
Still, analysts said Tuesday's data will not prevent the European Central Bank from raising interest rates by a quarter percentage point to 4.25 percent on Thursday.
Higher rates in Europe may further dampen the returns of U.S.-denominated assets.
"There is nothing really that has given the market reason to change the view that come Thursday, the ECB will raise interest rates by a quarter of a point," Halpenny at BTM said.
Markets have begun to take the view that the U.S. Federal Reserve has little scope to tighten monetary policy aggressively to fight inflation given the sluggish economy.
The greenback was down 0.2 percent against a basket of major currencies at 72.369, starting the third quarter of 2008 on the back foot.
The ISM report "should firm up the dollar a bit because one thing that's been going on over the last few days is the market is growing doubtful about the possibility of Fed rate hikes for the rest of the year," said Boris Schlossberg, a senior currency strategist at DailyFX.com, in New York.
"But if we see employment in dire straits and core job losses going forward, the Fed will find itself in the worst possible position -- between high inflation rates and slow growth. It will be like a deer frozen in headlights," he added.