Yen rebounds versus dollar on Japan minister's remark; euro slides

NEW YORK (Reuters) - The yen was on track for its biggest one-day gain against the dollar in eight months on Tuesday as a warning from a Japanese minister about the disadvantages of excessive yen weakness prompted investors to pare back bearish bets.

The euro, meanwhile, fell against the dollar after three straight days of gains, pressured by weak German data and the yen's strength across the board. Europe's shared currency was on pace for its worst showing versus the yen since June last year.

Expectations of aggressive action from the Bank of Japan to weaken the yen have driven the dollar and euro sharply higher in recent months. The greenback notched a nearly 11.3 percent gain in the fourth quarter of 2012 and has risen more than 2 percent so far this year.

However, remarks by Japanese Economics Minister Akira Amari on Tuesday made investors nervous about the yen's fall. He said excessive yen weakness could hurt people by raising import prices.

Amari's comments countered remarks made by officials over the past month that have strongly encouraged yen weakness.

With bets against the yen at lofty levels, many analysts contend the currency is poised for a short-covering rally, although it should prove temporary given widespread forecasts of forceful action from the BoJ to heal Japan's weak economy.

"The rally in the yen is a function of what Amari said overnight and the fact that global investors are taking money off the table for now because the dollar and euro have risen too far, too fast," said Sean Cotton, vice president and foreign exchange adviser at Bank of the West in San Ramon, California.

The dollar last traded down nearly 1.0 percent at 88.59, its worst day since May 2011.

Traders cited support at 88.20 yen, the dollar's 200-hour moving average, while reported stop-loss sell-orders at 89.50 yen could cap any recovery in the U.S. currency. Traders also cited option barriers at 90 yen.

The dollar hit a trough of 88.27 yen during the global session, but losses were pared in North America following the release of a slew of U.S. economic data.

U.S. retail sales rose solidly in December while manufacturing in New York state contracted for a sixth month in January. Other data showed inflation pressures remained muted, with U.S. producer prices falling in December for a third straight month.

That should allow the Federal Reserve to stay on its ultra- easy path to nurse the recovery, a negative for the dollar but a positive for risk appetite.

Nevertheless, the dollar may fare well over the next month as investors embrace its safety during a looming battle in Washington over raising the government's borrowing limit, the so-called debt ceiling.

Republican opposition in Congress to increase the $16.4 trillion ceiling raises the risk that the United States could default on its debt in the coming months.

The dollar's setback on Tuesday came a day after it hit 89.67 yen, its highest since June 2010.

Bets on aggressive easing from the Bank of Japan have weighed heavily on the yen in recent months. The BoJ has been under pressure from newly elected Prime Minister Shinzo Abe to adopt a 2 percent inflation target to beat deflation.

The BoJ holds its next policy meeting on January 21-22.

Amari's comments also buoyed the yen against the euro, with the single currency last trading down 1.3 percent at 118.17 yen. The euro on Monday hit 120.12, a 20-month peak.

EURO SLIDES

The euro, which is up about 1 percent against the dollar this year, slid on concerns about the U.S. debt ceiling debate and weak data from Germany, Europe's largest economy.

After reaching an 11-month high on Monday, the euro last traded at $1.3336, down 0.3 percent on the day.

The German economy was hit hard by the euro zone crisis in the final quarter of 2012, shrinking more than at any point in nearly three years as traditionally strong exports and investment slowed, the Statistics Office said on Tuesday.

The euro had been rallying in the aftermath of a European Central Bank meeting last week. Comments by ECB President Mario Draghi were largely seen as supportive and served to downplay expectations of a near-term rate cut.

Should data out of the euro zone continue to show economic weakness, the ECB could opt to lower rates to spur growth.

But despite its fall against the dollar and yen, the euro extended gains against the Swiss franc, rising to a fresh 13-month high. The euro rose to 1.2413, its highest level since December 2011.

The Swiss franc has come under selling pressure as concerns about the euro zone debt crisis have receded, prompting investors, who had bought the franc as a refuge from the euro's problems, to cut long positions.

"There is a general feeling that the cracks in the euro zone economy are starting to dissipate and it is beginning to stand on solid ground," said Bank of the West's Cotton.

(Additional reporting by Julie Haviv; Editing by Peter Galloway)