Yen Keeps Falling, Hits 4 1/2-Year Low vs. Dollar

Why the Dollar Won't Fall Off a Cliff

The yen fell against the dollar on Tuesday for a fourth straight session, hitting its lowest level in 4 1/2 years as signs that the U.S. economy is improving and a global equities rally favored the greenback.

The Japanese yen has been in a downward spiral since breaching the key 100-yen mark last week, partly as a result of aggressive monetary policy action from the Bank of Japan, as well as expectations that the U.S. Federal Reserve will taper its monthly bond buying sometime this year.

The dollar's recent strength against the yen is also a result of rallying U.S. equities, with the S&P 500 and Dow Jones indexes hitting intraday highs while European shares touched five-year highs.

(Read More: Stocks Hit New Highs as Financials Surge)

"There has been a breakdown with the correlation between dollar/yen and yield spreads. However, the currency and equities continue to move in tandem," said Camilla Sutton, chief currency strategist at Scotiabank in Toronto. "For upside to continue, which we expect, we will likely have to see a broadly stronger dollar combined with further evidence that investors are favoring moves outside Japan," she added.

Sutton holds a year-end dollar/yen forecast of 105 yen.

The dollar climbed as high as 102.31 yen on Tuesday—its highest in 4 1/2 years—and last traded at 102.20 yen, up 0.4 percent on the day.

The euro last traded at 132.30 yen, up 0.2 percent on the day.

The extended yen weakness came despite a spike in Japanese government bond yields, which tends to reduce the relative attractiveness of foreign bonds for investors in Japan.

The Bank of Japan could ease monetary policy as early as October if prices do not rise as quickly as projected, according to economists polled by Reuters who have also upgraded their growth forecasts.

But the dollar was underpinned by Monday's data showing U.S. retail sales rose unexpectedly in April, and it may gain further if upcoming U.S. economic data point to a recovery.

"We think against the yen the dollar can go higher, helped by rising U.S. yields," said Marcus Hettinger, FX strategist at Credit Suisse.


U.S. import prices fell in April due to a drop in oil costs, a positive sign for household finances that also pointed to benign inflation pressures. More U.S. data will emerge this week, including Wednesday's industrial production, housing starts and consumer prices on Thursday and consumer sentiment data on Friday.

Euro Steady vs. Dollar

The euro swung between minor gains and losses to last trade flat, with stronger-than-expected euro zone industrial output data offset showing German investor morale pointing to a tepid recovery in Europe's largest economy.

The euro got a slight boost after Fitch Ratings agency upgraded Greece's sovereign credit rating to B-minus from CCC, with a stable outlook.

The euro remains weighed down by the risk that the European Central Bank could slash its deposit rate, at which banks park surplus funds with it, to negative. Depositors would be charged for leaving funds at the ECB, which would pressure the euro.

Germany's ZEW think tank said its monthly poll of economic sentiment rose to 36.4 points from 36.3 in April, falling short of expectations for a reading of 38.3.

Other data, however, showed output at euro zone factories rose much more strongly than expected in March, but the overall picture remained mixed as industrial output decreased in France and Italy, the bloc's second- and third-largest economies.

(Read More: Euro Zone Factory Output Jumps on Energy, German Strength)

"The euro seesawed after the mixed data from the region largely offset (each other), keeping in place sentiment that's largely bearish," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington. "Expectations that the ECB might further cheapen borrowing rates to spur recovery at a time when the days of the Fed's super-easy monetary policies appear increasingly numbered have been among the chief catalysts driving the euro lower," he said.

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Growth will return to the euro zone's recession-mired economy in the second half of this year, but economists see no chance it will recover strongly until at least 2015, a Reuters poll showed on Tuesday.

While some ECB policymakers have talked openly of cutting the deposit rate below its current level of zero percent, a majority of economists and traders polled in the past week think such a move is unlikely.

The European Central Bank clashed with Germany on Tuesday over how quickly the euro zone should complete a system to deal with failing banks. The euro last traded flat against the dollar at $1.2974.