By Natsuko Waki
LONDON, Nov 26 - The yen found support on Monday after the Japanese government played down a newspaper report that the central bank would weaken the yen by buying foreign bonds.
Such comments and firmer Tokyo stocks helped the yen to reverse losses made after ratings agency Fitch cut Japan's sovereign credit rating and fellow agency Standard & Poors warned of a possible steep two-notch credit rating cut following its last downgrade in February.
Japanese Finance Minister Masajuro Shiokawa dampened speculation that Japan may buy foreign bonds to weaken the yen, saying the Bank of Japan had not decided on any such a move.
"Reports of buying foreign bonds conspired to weaken the yen last week although we didn't have any details. Denials from the Japanese officials highlighted the fact that it's not a viable strategy," said Henry Wilkes, head of the foreign exchange desk at Brown Brothers Harriman.
Shiokawa also said there were no formal discussions on the matter within the central bank. BOJ Governor Masaru Hayami said the purchase of foreign bonds was not an urgent issue.
Speculation that the United States would not object to Japan weakening its currency by buying foreign bonds was sparked last week by a report in the Financial Times and sent the yen sharply lower across the board.
By 1040 GMT, the yen stood at 124.08 , pulling itself off its 3-1/2 month lows of 124.48 hit last week.
Dollar losses against the yen helped push the euro higher to $0.8822 . The euro also powered ahead to two-week highs against the yen at 109.40 .
BUCKING TREND
Ratings agency Fitch dealt the latest blow to Japan, downgrading the country's credit rating to AA from AA-plus.
Adding insult to injury, Standard & Poor's warned that it might slash Japan's rating by two levels from the current AA+, putting it alongside borrowers such as Malta and the Czech Republic.
Some said it was hard to grasp any material impact from the actual downgrade given that foreign ownership of Japanese Government Bonds stands at just over five percent. Further limiting yen losses, the stock market pushed higher on Monday with Nikkei <.N225> ending at a three-month peak as investors focused on Friday's strength on Wall Street and took heart from signals Japan's troubled banks may be getting serious about cleaning up a mountain of bad loans.
But analysts doubted the yen would sustain its gains in the longer term.
"In the next couple of weeks I think the dollar will stay reasonably strong as focus shifts to more U.S. data," Wilkes said.
For this week, dealers said investors would keep an eye on November consumer confidence on Tuesday and October durable goods orders on Thursday.
They added any upward surprise on data could bring the dollar up again to 124.48, a break of which would open the way to 125 then 126.82, this year's low hit in April.
FIRMER EURO
Europe's single currency pushed higher in thin trade to stand near the day's highs around $0.8830 .
The euro was aided on Friday by sales of sterling linked to a pro-euro speech by British Prime Minister Tony Blair. But rumours he would set a date for a referendum on joining at the event proved wide of the mark and the pound has since rallied.
Dealers said they expected the euro to come under pressure this week with a batch of data expected to highlight weakness in the euro zone economy.
A re-weighting of the Morgan Stanley Capital International's global stock indices later this week was also seen undermining the euro, with the euro zone seen losing heavily to the United States and Britain.
"A combination of economic data and MSCI reweightings should weigh on the euro," said Mitul Kotecha, head of global currency research at Credit Agricole Indosuez.
News from Afghanistan was seen as generally dollar-positive with hundreds of U.S. marines taking up position near the last Taliban stronghold of Kandahar.
Traders noted early evidence on the holiday shopping season from the United States also seemed to favour the dollar. Treasury Secretary Paul O'Neill said Friday's post-holiday sales were up four percent from a year ago and the U.S. economy was headed for recovery.
On the other hand, it was possible that the National Bureau of Economic Research could declare this week that the United States was officially in recession.
The committee, which determines the official dates of recessions in the United States, held a conference call on Friday to decide whether the world's largest economy has slid into one.