(Reuters) - The dollar came off a two-week high against the yen on Friday, weighed down by the euro's gains on political progress in Spain, but was seen likely to recoup losses and firm further on views the Federal Reserve will not signal strong economic stimulus.
The greenback was also under pressure from the Australian dollar which gained on the Australian central bank chief's upbeat remarks about the country's economy, soothing worries over deep interest rate cuts.
Markets started the week thinking Bernanke may announce a third round of asset purchases or some other extraordinary policy later on Friday in a speech in Jackson Hole, Wyoming, pressuring the dollar. But this view has changed, giving the U.S. currency a broad boost on Thursday.
This was mostly because markets realized that despite sharp falls in stock markets, U.S. inflation is higher and the risk of a vicious deflationary cycle has diminished. While growth remains weak, Fed officials do not appear particularly concerned about recession risks.
"The market is still yen long and as the yen failed to get stronger (versus the dollar) we may see further unwinding of those positions ahead of Bernanke, boosted by lingering fears of intervention," said Koji Fukaya, director of global foreign exchange research at Credit Suisse Securities in Tokyo.
The dollar traded down 0.2 percent at 77.30 yen, coming off a two-week high hit overnight of 77.70 yen. It hit a record low of 75.941 yen a week ago, giving rise to jitters that Tokyo would intervene in currency markets for the second time in less than a month.
Traders say Japanese exporters may refrain from selling the dollar in their end-of-month transactions ahead of Bernanke's speech, hoping he does not announce QE3, which could spur further unwinding of dollar shorts, sending the dollar higher.
"Exporters sold quite a lot (of dollars) yesterday around 77.50 and now stronger offers are lined up around 78.30," said a trader for a major Japanese bank, adding that stop loss orders by speculators are seen around 76.80 yen.
Individual Japanese players were also spotted liquidating some yen-long positions ahead of the Jackson Hole speech, due to start at 10 a.m. EDT.
Charts indicate the pair is poised for a rebound, having formed a round-bottom pattern. Strong support looms at the daily tenkan line at 76.82 yen and the 21-day moving average at 77.12 yen, with resistance posed by the kijun line at 78.10 yen.
While Bernanke is expected to stop short of offering a grand economic fix, he may well signal a willingness to adjust the central bank's $2.8 trillion portfolio to try to get more bang for each buck, and some think this would be enough to send the dollar down.
"We believe the Fed's commitment to keeping policy rates low will re-ignite the USD's trend depreciation and push the greenback lower especially against higher-yielding growth currencies," said BNP Paribas strategist Steven Saywell.
"Anticipating an ongoing Fed commitment to easy monetary policy, we favor building short USD exposure," he said.
NUDGING HIGHER
Failure by the Fed to inject more dollars into the system could help the currency extend gains sharply as investors pull out of stocks and other risky assets. A euro slide below $1.4250 could speed up the dollar's gains, some analysts say.
The euro recouped mild losses sustained on Thursday, adding 0.2 percent to $1.4410 as stop loss-buying was triggered after Spain's government reached an agreement with the main opposition People's Party over plans to enshrine in its constitution limits on the public deficit.
The common European currency continued to exasperate traders, staying stuck in the middle of its well-trodden $1.4518-$1.4259 range, down from this week's peak near $1.4500.
With the euro-zone debt crisis back in full swing and two-year Greek yields hovering around record highs, investors say the euro may drop after Bernanke's speech as the market's focus will likely move back to Europe.
Wild talk that Germany may face a ratings downgrade and could introduce a short-selling ban sent Germany's DAX stock index 1.7 percent lower and also weighed on other equity markets on Thursday, though both rumors were later denied.
But some traders said Chinese demand for euros will cap the currency's losses.
French President Nicolas Sarkozy said on Thursday China's President Hu Jintao showed "definitive" confidence in the euro and the European economy despite some concerns, after the two leaders met in Beijing.
The Australian dollar rose 0.4 percent to $1.0472 after Australia's central bank chief said the country was well positioned to tackle any further weakening of international conditions.
The Aussie's march higher was stopped by strong resistance at its 21-day moving average of $1.0499, but it stayed well above its support at the 200-day moving average of $1.0336.
U.S. gross domestic product data for the April-June quarter is due later on Friday, with some risk it may be revised down to under 1 percent.
