TOKYO (Reuters) - The yen nudged lower against the dollar but was underpinned by risk aversion on Tuesday as Tokyo shares fell following a drop in U.S. stocks on deepening concerns about a global recession.
Weak stock markets may prompt more unwinding of carry trades, in which investors borrow the low-yielding yen to buy higher-yielding currencies and assets, traders said. That would put a cap on the dollar's rise against the yen.
Still, traders said that while the dollar was hurt by the weak state of the U.S. economy, investors' low risk appetite may support the dollar as investors seek refuge in U.S. Treasuries.
"Sluggish stocks point to yen and dollar buying on risk aversion," said Saburo Matsumoto, senior manager at Sumitomo Trust & Banking.
"Because of the huge carry trade volume built up over the past few years, there is still scope for the yen to strengthen as these positions are unwound, keeping it generally firm against the dollar," he said.
The dollar was up 0.2 percent at 96.66 yen, trading in a band between 96.24 yen and 96.78 yen.
Money market volatility despite aggressive interest rate cuts worldwide also bolsters demand for dollars, the world's most liquid currency, helping it keep a firm tone, traders said.
"The dollar is benefiting from shrinking money markets despite global monetary easing, given its status as the key settlement currency, even though there are concerns about the economy," Matsumoto said.
But the dollar's gains were also limited by concern over the fate of struggling U.S. corporations such as Citigroup, which plans massive jobs cuts, and ailing automakers such as General Motors Corp, Ford Motor Co and Chrysler LLC, dealers said.
"Until issues such as Citigroup and the U.S. auto industry are cleared, it would be difficult to step up dollar buying," said a manager at a Japanese bank.
The White House on Monday opposed Senate Democrats' proposal for a $25 billion bailout for the U.S. auto industry and urged instead that aid be provided through government loans already appropriated for the industry by Congress.
The euro eased 0.2 percent to $1.2620, and was little changed against the yen at 121.96 yen after falling as low as 121.44 on trading platform EBS.
The Australian dollar fell 0.4 percent to 62.44 yen. Sterling was up 0.1 percent to 144.81 yen, off lows near 143.95 yen and highs near 145.10 yen.
A Hong Kong-based trader at a European bank said a Japanese securities firm sold both the pound and the Australian dollar against the yen earlier in Asian trade, and also sold the euro against the yen through Tokyo's commercial fixing.
The Nikkei stock average was down 2 percent after falling as much as 2.5 percent earlier.
The Australian dollar fell as dovish comments from the country's central bank were taken as suggesting more sharp rate cuts ahead, traders said. The Aussie was trading at $0.6465. Minutes of the Reserve Bank of Australia's November meeting showed the board was increasingly worried about consumer and business sentiment and felt a larger-than-expected cut of 75 basis points to 5.25 percent was warranted.
Falling stock markets and deepening economic gloom weighed on money markets on Monday, pushing up interbank rates.
After U.S. Treasury Secretary Henry Paulson's comments about a change in focus for Washington's $700 billion bailout fund for financial markets, recessions in Japan and the euro zone and stock falls added to the anxiety in money markets, traders said.
Monday's weak U.S. manufacturing data also deepened worries about the global economy.
While separate data showed industrial output rose 1.3 percent in October after a revised September drop of 3.7 percent -- the biggest fall in more than 62 years -- the Philadelphia Federal Reserve Survey of Professional Forecasters said the U.S. economy dipped into recession last spring and will contract sharply this quarter.
(Additional reporting by Kaori Kaneko; Editing by Hugh Lawson)
