(Adds details, updates prices)
By Lucia Mutikani
NEW YORK, Oct 24 (Reuters) - The yen rose against the dollar and euro on Wednesday as weaker stocks and an unexpectedly softer September U.S. existing-home sales report caused investors to flee risky assets.
But U.S. stocks trimmed losses on speculation that the Federal Reserve might cut the discount rate imminently, curbing the Japanese currency's advance, which has also been driven by the unwinding of carry trades. The Fed declined to comment.
Carry trades are strategies where investors fund purchases of securities in high-yielding currencies by borrowing in a low-yielding currency such as the yen.
"We are seeing a degree of risk aversion creep back into the FX markets. The news from the U.S. banks in terms of write-downs today is weighing down equity (market) sentiment and that is having a spillover effect on to currencies such as the yen," said Mike Moran, foreign exchange strategist at Standard Chartered Bank in New York.
Moran was referring to Merrill Lynch & Co. Inc's (MER.N: Quote, Profile, Research) announcement of $7.9 billion in write-downs, related to problems with subprime mortgages, stemming from home loans in the United States to people with poor credit histories.
In late New York trade, the dollar was down 0.5 percent at 114.20 yen <JPY=>, after touching a session low of 113.82 yen. The euro fell 0.5 percent to 162.90 yen <EURJPY=>. It hit an intraday trough of 161.72.
"The 114 figure is very important support. We have tried to close below this level for the past five weeks and have failed. If have a close below the 114 figure it does open a risk for a test down to 113.20," said Moran.
The euro was flat at $1.4262 <EUR=>, while the dollar index eased 0.1 percent to 77.525 (.DXY: Quote, Profile, Research).
Merrill Lynch's write-downs and news that sales of previously owned homes dived to a record low annual pace of 5.04 million units in September were seen cementing the case for a Federal Reserve interest rate cut next week, adding to the dollar's woes.
"Today the housing data was so horrid that the market is almost assured of another rate cut from the Federal Reserve. That is compressing the interest rate differential between the the dollar and the yen," said Boris Schlossberg, senior strategist at Forex Capital Markets in New York.
U.S. short-term interest rate futures show investors have fully priced in the Fed cutting rates by 25 basis points from 4.75 percent at its Oct. 30-31 policy meeting (FFX7: Quote, Profile, Research). The Fed slashed its benchmark fed funds target rate by half a percentage point last month.
That contrasts with Europe where investors expect the European Central Bank to keep interest rates flat at 4.0 percent well into 2008 as policy-makers gauge the slowing of the economy.
"There is still some die-hard support for carry traders for dollar/yen, but with every rate cut that the Fed enacts, it makes the dollar/yen pair that much less unattractive as a carry pair and that's what's giving the yen strength to go forward," said Schlossberg.
Merrill Lynch's write-downs reminded investors of the troubles in the credit markets and helped to push U.S. and European equity markets lower. That also sparked speculation that a similar fate awaited other big U.S. financial institutions.
The Australian dollar rose after data showed underlying domestic inflation rose faster than expected last quarter, increasing the chance that the country's central bank would raise interest rates as early as November. It last traded up 0.4 percent at US$0.9021 <AUD=>.
The New Zealand dollar <NZD=> traded 0.3 percent down against the greenback at $0.7540 after the central bank left interest rates unchanged as expected. The U.S. dollar rose 0.2 percent versus the Canadian dollar at C$0.9683 <CAD=>.