(Updates price, adds quotes, changes byline)
By Natsuko Waki
LONDON, Aug 8 (Reuters) - The low-yielding yen fell against the dollar and euro on Wednesday after the Federal Reserve's statement cooled expectations for a near-term U.S. interest rate cut and boosted riskier assets.
The Fed left interest rates on hold at 5.25 percent on Tuesday as expected and acknowledged that financial markets have been volatile and tightening credit conditions have raised downside risks to the economy.
But it reiterated that controlling inflation remains its number one policy concern and said that despite the increase in risks to growth, the economy was still likely to expand at a moderate pace in coming quarters.
The statement left stocks higher, government bonds down and emerging market spreads tighter in a sign that risk appetite is improving after a sharp deterioration over the past few weeks triggered by fears of a global credit squeeze.
"We are back to playing the yen from the long side after the Fed. There is a yen story that relates to asset market and carry trades. Yen crosses are highly correlated with equity markets," said Nick Parsons, head of market strategy at nabCapital.
By 1000 GMT the dollar was up half a percent at 119.28 yen <JPY=>, more than two yen up from this week's four-month low. Against the yen the euro was up almost 0.6 percent at 164.16 yen <JPY=> and against the dollar it was up 0.1 percent at $1.3761 <EUR=>.
The dollar index (.DXY: Quote, Profile, Research), a measure of the greenback's value against a basket of six major currencies, was unchanged on the day, having hit a 15-year low on Monday.
Financial markets had gone into the Fed meeting fully discounting a one quarter point rate cut by the end of the year. They have since scaled that back to around a 75 percent probability.
Parsons said in the longer-term the Fed is poised to cut. "The Fed is gradually opening door for a rate cut which we think will come in the first quarter of 2008. The Fed never cuts once. We think there will be three cuts in the first half of next year."
CARRY AND REPRICING
The higher-yielding Australian dollar <AUD=> rose 0.3 percent against the U.S. currency after the Reserve Bank of Australia raised interest rates a quarter point to 6.5 percent.
That's the highest cost of borrowing in Australia for 11 years, and maintains the Aussie dollar's status as one of the highest-yielding currencies in the industrialised world.
Higher-yielding assets are posting gains on Wednesday after broader correction in the past couple of weeks, triggered by broader credit and risk repricing in the wake of a fallout in the U.S. housing market.
HBOS said while recent market volatility was unlikely to bring an emergency Fed easing, economic fundamentals will eventually deteriorate, ending tightening cycle outside the United States and prompting the Fed to cut interest rates.
"We expect the Federal Reserve will be very slow to cut rates - it needs to free up substantial spare capacity in the U.S. economy before it can stimulate again," it said in a note.
"This should allow a dollar positive move in expected short-term interest rate differentials to develop even in the context of an economic slowdown."