NEW YORK The U.S. dollar rose on Tuesday against the yen for a second straight session as some traders bet the Federal Reserve may signal it is almost ready to reduce its bond buying program aimed at propping up the economy.
The euro hit a four-month high against the dollar after a survey showed German analyst and investor sentiment rose for a second consecutive month in June, suggesting Europe's largest economy is on track for a modest recovery.
While many see the U.S. central bank trimming asset purchases this year, most see higher overnight interest rates as distant. Analysts say Federal Reserve chairman Ben Bernanke, who will hold a news conference after a two-day policy meeting ends on Wednesday, will try to soothe investor nerves.
Uncertainty about the Fed has led to a selloff in global stocks in recent weeks, lifting the safe-haven yen last week to its best weekly gain in nearly four years against the dollar.
"Even if they're considering tapering moving forward, tapering isn't tightening. They're still going to be easing, they're still going to be expanding their balance sheet. They wouldn't be tightening until they start to shrink the balance sheet," said Eric Viloria, currency strategist at Forex.com in New York.
A winding down of the central bank's $85 billion-a-month bond purchases would boost the dollar, which has been hit by the Fed's money-printing program over the past several years.
"The yen's fresh leg lower today could be a sign that many investors think the Fed will signal a reasonable chance of a taper as later in the third quarter," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington.
"The yen is seen vulnerable to less policy accommodation from the Fed, a move that would tend to put upward pressure on U.S. Treasury yields, burnishing the greenback's allure."
The dollar rose 0.99 percent to 95.43 yen, having hit a two-month low of 93.78 yen on Thursday.
The euro rose 1.12 percent to 127.77 yen. Against the dollar, the euro rose 0.22 percent to $1.3396, having reached a four-month high of $1.3415.
The dollar index, which measures the greenback versus a basket of currencies, slipped 0.16 percent to 80.656 .DXY.
Some investors think inflation below the Fed's target of 2 percent potentially complicates the Fed's ability to reduce bond purchases, lest the reduced stimulus causes inflation to continue to fall.
The U.S. Consumer Price Index edged 0.1 percent higher in May, the government said on Tuesday, which was slightly weaker than analysts polled by Reuters expected though price pressures showed signs of stabilizing after a long decline.
Should the Fed reaffirm its commitment to the current pace of bond-buying, the dollar could see some near-term weakness, analysts said.
But they said the yen's outlook may depend more on investor sentiment for risk. Since Japanese Prime Minister Shinzo Abe called late last year for radical monetary easing to revive the economy, dollar/yen has been driven higher by rises in Japanese share prices.
Heading into Wednesday's Tokyo trading session, September Nikkei stock futures pointed to a higher open, with contracts traded in Chicago up 260 points at 13,350.
Worries China is slowing, coupled with talk of a scaleback in central bank liquidity, led to a stock selloff and a sharp rise in volatility. This drove investors to the yen, which tends to benefit in times of market turmoil.
(Editing by Chizu Nomiyama, Nick Zieminski and Bob Burgdorfer)