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Dollar, Euro Lose Ground Against Yen

The dollar and other major currencies fell against the yen as investors further unwound overextended positions against the currency amid concerns the Group of Seven rich nations may address its weakness at a meeting next month.

The yen, which shed about 10% against the dollar last year, rallied on Wednesday after a source close to the preparation of next month's G7 talks said Europe would seek a more forceful message on the yen's weakness.

However, German Deputy Economy Minister Bernd Pfaffenbach, the top German official responsible for preparing the G7 summit, said on Thursday that Germany was not planning to put the yen on the meeting's agenda.

Hiroshi Watanabe, Japan's top financial diplomat, also said he did not think the yen would be a major topic at the talks.

"We have all these officials talking about the yen, which tells me that between now and the G7 meeting we are going to see a lot of volatility on the currency," said Andrew Busch, global foreign exchange strategist at BMO Capital Markets in Chicago. "The risk at this time is for a big unwind on the carry trade, which for now, supports the yen."

In a sign the yen may be moving out of its recent trading ranges, there has been a rise in implied volatility in the foreign exchange options market.

Implied volatility on one-month dollar/yen options hit a seven-week high of 7.7%, while euro/yen volatility hit a six-month peak of 7.8%.

Investors have been using the yen as part of the carry trade, in which a low-yielding currency is sold to finance the purchase of higher-yielding assets.

Asian Development Bank President Haruhiko Kuroda said yen weakness from carry trades had gone too far and that he saw a risk they will unwind within two years. His comments gave further support to the yen.

The reversal of carry trades was exacerbated by weakness in high-yielding currencies after dovish Bank of England minutes and below-forecast Australian inflation on Wednesday dampened expectations of further rate hikes in these two countries, traders said.

In the United States, the dollar hardly reacted after a report showed existing home sales fell more than expected in December. The decline in 2006 in existing home sales was the biggest since 1989.

"Pressure on the dollar has abated a bit for the time being as people over the last 24 hours have been more concerned with assessing whether or not there will be direct or verbal action taken to stem yen weakness," said John McCarthy, director of foreign exchange at ING Capital Markets, in New York. "With that, the U.S. numbers are not going to have an enormous impact
this week."

The euro inched higher against the dollar, reversing a brief fall sustained after a weaker-than-expected reading from the German Ifo business sentiment survey earlier in the session.

The Ifo's headline index slipped to 107.9 from December's 108.7, confounding forecasts for a rise to 109.