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LONDON (Thomson Financial) - The dollar dropped below the 110 yen mark for the first time in a year and a half before recovering slightly but is likely to remain on the backfoot because of rising risk aversion in the wake of mounting concerns about the impact of the subprime crisis on the US economy.

Rising risk aversion prompted a further reduction in carry trades, which pushed the dollar to a low of 109.82 yen, its lowest level since May 2006.

"Although the euro continues to trade close to its all-time highs and still tries to push higher, dollar losses have been pronounced against the low yielding currencies due to rising risk aversion over the last days," said Gavin Friend, currency strategist at Commerzbank.

"We think the dollar will broadly remain on the defensive, especially against the yen and the Swiss franc, but we don't exclude a short-term retracement, given today's holiday in the US," he added.

Analysts noted that the yen's return to favour in recent days and weeks has not all been about the weakness in the dollar. The acceleration in the appreciation of the Chinese yuan has also helped the Japanese currency against the Swiss franc.

Daragh Maher, senior forex strategist at Calyon, noted that in 2003 and 2004, dollar/yen moved hand-in-hand with developments in the Chinese yuan.

"It is far too early to say if this relationship is about to be rekindled, but with the whole yuan debate gathering greater prominence, it should continue to favour the yen," he added.

Another record Chinese trade surplus in October has stoked talk of further appreciation in the yuan and/or another interest rate rise from the People's Bank of China.

In addition, Maher said US coupon payments and associated repatriation of funds back to Japan are also likely to feature during the week as a yen positive.

"The danger as ever is that the yen's fortunes to a large extent hinge on elements outside of Japan, and any resurgence in risk appetite would clearly have the yen on the back foot once again," he added.

With very little economic data and US trading trimmed by Veteran's Day, currency markets are likely to take their cue from equity markets, which appear to have steadied after Friday's losses.

US economic data, particularly retail sales and inflation numbers, over the coming few days will be closely monitored to see if they fuel market expectations of another interest rate cut to 4.25 pct in December from the US Federal Reserve.

The pound is also likely to be in focus this week as a raft of economic data will help determine if and when the Bank of England will be cutting interest rates.

Wednesday's Inflation Report from the central bank will be closely monitored. Though it is expected to paint a gloomier picture of the UK economy's prospects for 2008 than previous ones, the BoE is still likely to emphasise ongoing inflationary pressures.

Downbeat predictions about the economic outlook in the UK, fuelled by Friday's sharp decline in banking stocks, has pushed the pound down to its lowest level since January 2005 against the euro.

London 0851 GMT Hong Kong 1 pm (0500 GMT)

US dollar

yen 110.46 up from 110.05

sfr 1.1253 up from 1.1239

Euro

usd 1.4626 down from 1.4638

yen 161.58 up from 161.18

sfr 1.6463 up from 1.6455

stg 0.7030 down from 0.7042

Sterling

usd 2.0805 up from 2.0783

yen 229.77 up from 228.81

sfr 2.3416 up from 2.3358

Australian dollar

usd 0.8947 up from 0.8932

stg 0.4299 up from 0.4296

yen 98.82 up from 98.33

pan.pylas@thomson.com

/pp/jfr

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