The dollar spiked higher against the yen Thursday after a leading credit ratings agency downgraded its view on Japan's debt amid concerns over its elevated borrowings.
Stock markets mostly traded higher, however, after the U.S. Federal Reserve gave few, if any, indications that it is thinking about changing its expansionary policy anytime soon, despite some soft U.S. economic data Thursday.
The Fed's comments gave investors encouragement that interest rates will remain at historically low levels and that the central bank will continue its program to pump $600 billion in newly created money into the U.S. economy _ a welcome combination for stock market investors.
But the main development in the markets Thursday was the news that Standard & Poor's cut its rating on Japan's debt by one notch to AA minus from AA. Though the agency had Japan on notice for a downgrade, the scale of its criticism of Japan's efforts to get a grip on its debts was surprising.
"By tossing the scale of Japan's fiscal challenges under the spotlight the S&P move shook investors' willingness to treat it as a safe haven," said Andrew Wilkinson, senior market analyst at Interactive Brokers.
By mid-afternoon London time, the dollar was trading 0.8 percent higher on the day at 82.86 yen after trading as high as 83.20 yen.
The agency projected that Japan's fiscal deficit will remain high for the next few years and that the government will have difficulty managing its debt amid persistent deflation and a rapidly aging population.
It is forecasting Japan's annual fiscal deficit will fall only modestly from an estimated 9.1 percent of national income in the fiscal year 2010 to 8 percent in fiscal 2013.
Japan's debts have raised concerns for many years and its cumulative national debt is nearly twice annual economic output.
However, worry has been restrained because most of the debt is held by domestic investors _ only around 4.5 percent of Japanese government bonds are held by foreigners.
Derek Halpenny, European head of global currency research at the Bank of Tokyo-Mitsubish UFJ, said the downgrade "will certainly up the pressure on the government to become more pro-active in creating a long-term fiscal strategy."
The downgrade had no impact on Asian stocks as it was released after markets closed. Japan's Nikkei 225 stock average closed 0.7 percent higher at 10,478.66 after the Finance Ministry announced that export growth had accelerated for the second straight month in December, indicating a revival of overseas demand.
Japan's debt issues have come to the surface at a time when concerns over Europe's debt crisis have diminished somewhat amid growing signs that policymakers have gotten a grip on the situation.
French President Nicolas Sarkozy could not have been clearer about his support for the currency.
In a speech in Davos, Switzerland, Sarkozy vowed that he and European partners will "never turn our backs on the euro," calling it a linchpin of peace and prosperity despite the government debt crises worrying investors and leaders worldwide.
His comments helped the euro run up to a fresh two-month high of $1.3759 before a modest retreat to $1.3721.
In little over two weeks, the euro has rallied nearly ten U.S. cents on hopes that Europe's policymakers are honing their crisis management skills, clear pledges of support from Japan and China and mounting concerns about the recent uptick in inflation within the European Central Bank.
Lorenzo Bini Smaghi, Italy's representative on the ECB's rate-setting governing council, became the latest to voice his concerns about rising inflation.
Though the bank is expected to keep its main interest rate unchanged at the record low of 1 percent at its meeting next week, the change of tone surrounding inflation has ratcheted up expectations that the ECB may start raising rates sooner than expected despite the problems afflicting a number of countries within the eurozone.
Figures Thursday from the German states indicated that price pressures are getting a bit more acute, with five of them reporting rising inflation during January.
Given these factors, many analysts think the euro will likely remain well-supported in the coming weeks, provided there isn't another flashpoint in the debt crisis.
"The euro now appears likely to test its mid-November highs ($1.4214)," said Vassili Serebriakov, currency strategist at Wells Fargo Bank.
European stocks were also up, with Germany's DAX up 0.5 percent at 7,162 and the CAC-40 in France 0.4 percent firmer at 4,064. The FTSE 100 index of leading British shares was up 0.3 percent at 5,987.
Wall Street had a less buoyant opening after exceptionally soft weekly jobless claims figures and monthly durable goods orders.
The Dow Jones industrial average was more or less flat at 11,991 while the broader Standard & Poor's 500 index rallied around 3 points to 1,299.
Earlier in Asia, South Korea's Kospi added 0.2 percent to 2,115.01 while Hong Kong's Hang Seng fell 0.3 percent to 23,779.62.
The Shanghai Composite Index climbed 1.5 percent to 2,749.15, and the Shenzhen Composite Index for China's smaller, second market rose 1.8 percent to 1,174.67 after struggling to achieve gains earlier in the new year.
Investors have been nervously anticipating China's likely next step to dampen inflation _ namely a hike in interest rates ahead of the Lunar New Year holiday next week. They have hiked interest rates twice in the past four months and repeatedly tightened investment curbs to keep inflation from spreading throughout the economy.
Benchmark crude for March delivery was down 33 cents at $87 a barrel in electronic trading on the New York Mercantile Exchange.
Pamela Sampson in Bangkok contributed to this report.