The yen fell to a two-year low against the dollar on Wednesday after Japan swore in a new prime minister who has called for weakening the currency to stimulate inflation, while U.S. stocks slipped in thin trading.
The dollar rose as high as 85.74 yen on trading platform EBS, the highest since September 2010, following the swearing-in of Shinzo Abe as premier and was last at 85.65. The euro rose as high as 113.40 yen, a 16-month high, up 1.4 percent. The euro was at $1.3223 against the dollar, up 0.3 percent.
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Abe is calling for a mix of aggressive monetary policy easing and big fiscal spending to beat deflation and weaken the yen. He is pressuring the Bank of Japan to adopt a 2 percent inflation target that would auger for a weaker currency, threatening changes at the central bank if his wishes are not met.
"The election of Abe has had a galvanizing effect on the dollar/yen exchange rate and he has been able to accomplish more in two months of jawboning than the BoJ has... over the past several years," said Boris Schlossberg, managing director of FX strategy at BK Asset Management in New York.
U.S. shares were slightly lower in post-Christmas trading, picking up from losses on Monday, as Congress looks likely to fail to negotiate a deal to avoid the "fiscal cliff," a series of $600 billion in spending cuts and tax hikes that would slow the U.S. economy sharply unless lawmakers take action.
A U.S. official said on Tuesday that President Barack Obama may return to Washington from his Hawaiian holiday as early as Wednesday evening to resume talks.
With odds increasing that Congress will not come to an agreement before the end of the year, a series of big decisions will wait until early 2013, when tax rates are scheduled to rise for most Americans. Economists warn that the world's largest economy could fall into recession if the automatic tax hikes and spending cuts are not offset in some way.
U.S. stocks have held in a tight range, recovering losses sustained just after the U.S. election in November. The S&P 500 is still up about 13 percent on the year.
"No one is hitting the panic button yet and part of that lack of panic selling is the notion that (Wall) Street is getting comfortable with the likelihood of a temporary fix for the fiscal cliff - something that gets us over the date of January 1 in a way where it can be re-addressed," said Peter Kenny, managing director at Knight Capital in Jersey City, New Jersey.
There is some concern that the impending tax hikes cut into holiday spending in the United States. Holiday-related sales were up 0.7 percent from October 28 through December 24, compared with a 2 percent increase in 2011, according to MasterCard Advisors SpendingPulse.
The Dow Jones industrial average dropped 53.68 points, or 0.41 percent, at 13,085.40. The Standard & Poor's 500 Index was down 9.13 points, or 0.64 percent, at 1,417.53. The Nasdaq Composite Index was down 27.69 points, or 0.92 percent, at 2,984.91.
Many markets remained closed following Christmas. European exchanges were largely shuttered, and Hong Kong and Australia were also closed. The MSCI All-World Index <.MIWD00000PUS> was down 0.15 percent on Wednesday.
U.S. single-family home prices rose in October for the ninth month in a row. The S&P/Case Shiller composite index of 20 metropolitan areas gained 0.7 percent in October on a seasonally adjusted basis, stronger than the 0.5 percent rise forecast by economists polled by Reuters.
Ten-year U.S. Treasury notes rose 8/32 of a point in price to yield roughly 1.7476 percent. The U.S. bond market was closed on Tuesday for Christmas.
Brent crude climbed above $110 per barrel on Wednesday, hitting a two-month high, with investors hoping for a last-minute deal to avoid a U.S. fiscal crisis. U.S. crude futures gained $2.30, or 2.6 percent, to $90.91.
The weaker yen has bolstered hopes for better earnings from Japanese companies and underpinned the Nikkei, which has gained about 18 percent since mid-November, when the election was scheduled. The yen has lost nearly 8 percent against the dollar in the same period.
The Nikkei <.N225> closed at a nine-month high on Wednesday, with a 1.5 percent gain.
Minutes of the BOJ's policy-setting meeting in November, released on Wednesday, showed that some board members said the central bank must act decisively, without ruling out any policy options, if the outlook for the economy and prices worsens further.
MSCI's broadest index of Asia-Pacific shares outside Japan <.MIAPJ0000PUS> was little changed. Shanghai shares were flat, but stayed in positive territory on the year after a 2.5 percent jump on Tuesday erased 2012 losses. It is set for a first annual gain in three years.
(Additional reporting by Ayai Tomisawa and Dominic Lau in Tokyo and Masayuki Kitano in Singapore; Editing by Richard Borsuk and Dan Grebler)