The yen hit a 20-month low against the dollar on Tuesday as Japan's incoming prime minister stepped up pressure on the Bank of Japan (BOJ) to easy monetary policy, while the dollar was buoyed by uncertainty about U.S. budget talks.
The Japanese currency still held above major chart support levels, thanks in part to slow activity with many trading centres closed for Christmas holidays.
The dollar rose as high as 84.965 yen, its peak since April 2011, before giving up gains to last stand at 84.84 yen,
Shinzo Abe, who is set to become Prime Minister on Wednesday, wants the BOJ to adopt a higher, more explicit inflation target. Abe also threatened to revise a law guaranteeing the BOJ's independence should his demand for a binding 2 percent inflation target - double its current goal - not be met in January.
He said he will pick someone who agrees with his views on the need for bolder monetary easing to succeed BOJ Governor Masaaki Shirakawa when his term expires in April next year.
While the prospect of a radical change in BOJ policy is likely to keep the yen under pressure, it was supported at its 200-week moving average around 84.95 yen.
More major support is also seen at 85.53, its April 2011 trough. "While we have no reason to buy yen now, there's no denying the yen's fall has been driven by speculators and expectations," said Makoto Noji, senior strategist at SMBC Nikko Securities.
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"But at the end of the day, whatever the inflation target the BOJ has, there's not so much the BOJ can do, other than buying government debts for more easing. So at some point, traders will take money off this (yen-selling) trade," he added.
The dollar was also broadly supported against riskier currencies as U.S. politicians struggle to reach an agreement to avoid a "fiscal cliff" of spending cuts and tax rises starting in January.
Some U.S. lawmakers voiced concern on Sunday that the country would go over the cliff, possibly sending the world's biggest economy into recession, although many in the market hope for a deal ahead of the year-end deadline.
The dollar index stood flat at 79.659, near its 10-day high of 79.71 hit on Monday. In one positive technical sign, the index rose above tenkan line on the daily Ichimoku chart, which stood at 79.52 on Tuesday.
The euro traded at $1.3181, down from its 7 1/2-month high of $1.33085 hit last week, but little changed on the day.
The Australian dollar also stayed near one-month low hit on Monday, fetching $1.0367, just above Monday's low of $1.0357.