The yen rose across the board on Wednesday as a rebound in the euro and commodity currencies faded, with the market on watch for clues about the health of the banking system as a key to longer-term direction. The currency market is highly volatile at the moment, reversing steep moves from one day to the next, and the euro gained on Tuesday as an improvement in German investor confidence lifted stock markets and helped commodity currencies higher. But that move ran out of steam and the market was reluctant to push the euro, the dollar or the commodity currencies higher against the yen in the wait for clarity on the health of the U.S. banking sector and on the future of automaker Chrysler. Instead traders reported euro selling for yen by model-driven funds on Wednesday as choppy, short-term trading dominated. "The market looks at a stage of deciding whether to go long in yen again or not, after being pretty much done with cutting yen-shorts," a trader at a Japanese bank said. The yen had been a favorite to sell against commodity currencies such as the Australian dollar as equity markets rose in recent weeks and optimism picked up that the global downturn was bottoming out. Those short yen positions have been cut since early April due to uncertainty over factors such as the next step in European Central Bank policy and stress tests for U.S. banks, but the market is unsure how far to chase the yen up from here. The euro fell 0.1 percent to $1.2925, holding above this week's one-month low at $1.2888, and shed 0.7 percent to 126.90 yen after jumping nearly 1 percent on Tuesday. The dollar shed 0.5 percent to 98.15 yen after gaining 0.8 percent on Tuesday. It hit a six-month high of 101.45 on April 6 but has gradually fallen since then. "Yesterday's rally was just a correction from the sharp decline in equity markets and the dollar/yen and yen crosses. The general feeling is that the market is not dominated by optimism -- the markets are beginning to react to negative news," said Masafumi Yamamoto, head of FX strategy Japan at Royal Bank of Scotland. "Any (dollar/yen) rally should be a good chance to sell and Japanese exporters keep that in mind." WHERE NEXT The ECB is expected to cut interest rates from 1.25 percent to 1.0 percent in May but it is unclear whether it will follow the Federal Reserve and other central banks and create money via other means such as buying corporate or sovereign debt. ECB Governing Council member Axel Weber told the Financial Times in an interview that the central bank had marginal room for more rate cuts and the euro zone had very limited scope in buying government debt in the secondary markets. The market is awaiting the outcome of the U.S. authorities' stress tests on banks. U.S. officials are expected to release details of the underlying assumptions of the test on Friday, but actual results are not expected until May 4.

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