By Wayne Cole // TOKYO, July 2 - The dollar briefly touched a three-month high on the yen after a key business survey confirmed the market's belief that Japan's poor fundamentals justified a weaker currency.
The dollar also had the euro under pressure again as bears bet the European Central Bank would be too wary of inflation to cut interest rates at its meeting this week.
The Bank of Japan's survey of business sentiment among big manufacturers showed a sharp fall in its main diffusion index to minus 16 in June from minus five in March and contributed to a near two percent fall in the Nikkei share average .
However, the fall in the index was exactly in line with analysts forecasts in a poll, while dealers had been braced for a result as bad as minus 20.
And the index for non-manufacturers stayed at minus-13 when a drop to minus 18 was expected and manufacturers actually revised up their capital expenditure plans.
"There were a few upside surprises, particularly on lending conditions which didn't show the sort of deterioration everyone was expecting," said James Malcolm, an economist at J.P. Morgan.
"(This) suggests we're not getting the sort of credit crunch that exasperated the recession in 1998," he added.
Furthermore, a weekend meeting between Japanese Prime Minister Junichiro Koizumi and U.S. President George W. Bush ended with no discussion on foreign exchange levels, countering speculation about an agreement on allowing the yen to ease.
Instead, would-be yen sellers were cautious in case Japanese officials repeated their concerns about the yen falling too far, too fast, warnings which saw the yen rally last Friday.
NOT GLOOMY ENOUGH
Thus while the dollar did briefly change hands at 125.00 yen through brokers, it quickly faded to 124.63 in late morning trade, leaving it a shade softer than New York's late 124.67.
Dealers said 125.00 was again proving a tough barrier to break, noting that apart from a short period in April the dollar has not been above there since October 1998.
Nevertheless, analysts believe Japan is already in recession, and might not recover for some time given the government's painful reform plans, so most are still tipping a gradual fall toward 130.00.
"If anything, we suspect manufacturers were too optimistic in the tankan," said Malcolm at J.P. Morgan.
"The pickup they're expecting in the second half would require both a strong recovery in the U.S. and a recovery in domestic demand, which we are frankly sceptical of."
DITTO FOR THE ECB
The euro also eased back on the yen to 105.70 from 105.91 in New York on Friday, while drifting to $0.8484 against the dollar from $0.8498.
That was above last week's 2-1/2-week lows around $0.8428 but dealers saw risks leaning to the downside given the market's perception that the ECB is not as concerned about the euro-zone economy as it should be.
Some analysts have been hoping the bank would bite the bullet and ease policy at its meeting this Thursday but the latest comments from officials are ambiguous at best.
On Friday, for instance, ECB chief economist Otmar Issing seemed to hold out hope for an easing by arguing that inflation would fall below two percent next year.
But Bundesbank President Ernst Welteke said it was still unclear whether there was a downward trend in inflation and the ECB had no reason as yet to be satisfied.
The Bank of England and the Swedish Riksbank also hold policy meetings this week but analysts are rather more confident that there will be no change at either.
Elsewhere, the dollar edged up to 1.7960 Swiss francs from 1.7935 on Friday thanks in part to talk a major Swiss bank had advised clients to buy dollar/Swiss for a run toward the psychological 2.0000 franc level.