TOKYO, June 18 - The yen was on the defensive against the dollar on Monday amid growing pessimism over the Japanese economy, while speculation that the European Central Bank (ECB) might aid the euro supported the single currency.
"The Japanese economic outlook is deteriorating, making it more likely that the Bank of Japan (BOJ) would ease monetary policy further," said Taisuke Tanaka, strategist at Credit Suisse First Boston.
Last week, data showed the economy contracted in the first quarter, although most had not expected a slowdown before the second quarter.
And the market was preparing for more bad news, with the BOJ's monthly economic report due out at 0500 GMT.
"The BOJ looks set to downgrade its view on the economy at its monthly economic report," said Hideyuki Tsukamoto, a manager for Fuji Bank's foreign exchange department.
If it indeed does, it would only be a matter of time before the central bank takes more drastic easing steps, possibly increasing its provision of funds in the market from five trillion yen ($40.70 billion) currently, analysts said.
Last Friday, the BOJ kept its ultra-easy policy unchanged.
The dollar is likely to keep its upper hand on the yen for now because any increase in the supply of yen funds is likely to weigh on its value, they added.
But on Monday morning, the dollar's rise was limited as Japanese exporters took the advantage to sell the dollar at its highest levels in one month.
"Exporters were placing offers around 123 yen," said Fuji Bank's Tsukamoto, explaining why the dollar failed to touch its four-week high of 123.25 yen hit in New York on Friday.
The dollar was little changed at 122.92/97 yen, compared with 122.89 yen in late New York trade on Friday.
The dollar soared more than two yen in New York, which some linked to the reallocation of assets out of Japan ahead of changes to the FTSE's global market index on Monday.
The euro was slightly firm on the dollar at 86.26 cents, against 86.11 cents at the end of last week. Against the yen, the single currency ticked up to 106.04/15 yen , compared with 105.83 yen in late New York.
Dealers said the euro was supported by speculation in some quarters that the European Central Bank (ECB) might intervene to prop up the currency after Sweden's central bank, the Riksbank, bought the Swedish crown against the dollar and the euro, dealers said. But many market players were not confident about the ECB's intention or prospects of success.
"(Bundesbank President Ernst) Welteke has been stepping up his efforts to rein in the euro's fall. But the question is whether the U.S. government is ready to cooperate with the ECB," said Tanaka of CSFB, noting the administration has expressed criticism of market intervention in the past. ($1=122.85 Yen)