By Lucia Mutikani
NEW YORK, Nov 9 (Reuters) - The Japanese yen hit a 1-1/2 year high against the dollar on Friday as fears of wider credit-related losses at U.S. financial firms dulled investors' appetite for risk, causing an unwinding of carry trades.
Moves to cut back on carry trades, which involve borrowing low-yielding currencies such as the yen to fund purchases of higher-yield currencies and assets, sparked the biggest weekly drop in the dollar against the yen since March.
A report that showed falling house prices and high energy costs had pushed U.S. consumer confidence to its lowest level in two years added to the dollar's woes and led investors to bet on more interest-rate cuts from the Federal Reserve.
"Fear is predominant in the market that the worst is not behind us in the subprime sector. As a result, all risk is getting liquidated and the yen benefits tremendously when the carry trades get unwound," said Boris Schlossberg, senior currency strategist at DailyFX.com in New York.
The dollar dropped as low as 110.52 yen <JPY=>, its lowest level against the Japanese currency since May 2006, according to Reuters data. It was last trading at 110.85 yen, down 1.6 percent on the day.
The yen also rose on the crosses, with the euro dropping 1.6 percent to 162.60 yen <EURJPY=>.
Ashraf Laidi, chief market analyst at CMC Markets, said a dollar drop to 110 yen and possibly beyond is likely early next week and predicted dollar selling will pick up even more steam if forthcoming U.S. retail sales data disappoints.
"That will amount to the other shoe dropping for the dollar," he said. "It will give people confidence to keep selling dollars as it suggests the housing and credit trouble is hurting individual consumers."
The euro hit a peak of $1.4752, its highest level since its inception in 1999, according to Reuters data. It was last trading at $1.4669 <EUR=>, steady with levels seen late Thursday.
An unexpected narrowing in the U.S. trade deficit in September afforded the dollar some respite against the euro, traders said.
But fears that more U.S. financial firms will be hit by credit market turmoil escalated on Friday after Wachovia Corp (WB.N: Quote, Profile, Research) said it had incurred about $1.1 billion of further losses from the credit market crisis and that it expects increased loan losses in the fourth quarter.
Speculation also swirled that British bank Barclays Plc (BARC.L: Quote, Profile, Research) was about to announce a $10 billion write-down. Barclays denied the rumors.
Heightened risk aversion sent key European and U.S. stocks tumbling, with the effects spreading to the high-yielding currencies such as sterling as well as the Australian and New Zealand dollars.
Sterling fell 0.8 percent to $2.0914 <GBP=> against the dollar, retreating from 26-year highs. The Australian dollar <AUD=> dropped 1.5 percent to US$0.9133, descending from 23-1/2-year peaks scaled on Wednesday.
The New Zealand dollar <NZD=> tumbled 1.3 percent to US$0.7662, while the dollar climbed 0.9 percent to 94.24 Canadian cents <CAD=>.