Array

TOKYO, July 3 (Reuters) The dollar recovered from a three-week low against the yen on Monday after the Japanese currency was unable to sustain a rally triggered by an upbeat survey of corporate sentiment.

The yen initially rose after the Bank of Japan's quarterly tankan poll for June produced a headline diffusion index of plus 21, a tad lower than forecasts but up from plus 20 in March and helping to pave the way for the BOJ to possibly raise interest rates from zero next week.

But the yen's gains were short lived due to dollar buying by Japanese importers and mutual funds, whose demand for the U.S.

currency underlines interest among investors in higher-yielding currencies even as domestic rates look set to rise.

''People had sold dollars going into the figure, and the reaction after the data was quite small,'' said Luke Waddington, head of forex trading at Royal Bank of Scotland. ''So people have had to cover those short positions.'' By 0330 GMT, the U.S. currency rose to 114.60 yen from around 114.45 yen in late U.S. trade on Friday.

It had fallen to 114.10 yen, its lowest level since mid-June, soon after the tankan was released.

Some analysts said that the yen had room to gain leading up to the BOJ's two-day policy meeting beginning on July 13.

''Given the tankan result, consensus is building that the BOJ will raise rates at its meeting next week,'' said Nobuo Ibaraki, forex manager at Nomura Trust and Banking.

Behind the healthy tankan reading was company plans to boost capital spending in the business year ending in March, and expectations for sentiment to improve further in September.

The euro was at $1.2785, slightly lower on the day but near a 3-week high of $1.2794 struck on Friday.

Traders said the euro remained well supported after strong economic data from the euro zone late last week kept expectations brewing that the European Central Bank would raise interest rates soon.

Although the ECB is seen leaving rates on hold at its policy meeting this week, many are betting on a rate rise in August following a bump up to 2.75 percent last month.

The euro edged up to 146.45 yen.

The dollar's gains against the yen helped the euro to recover from a slide to around 145.95 yen and put it back in sight of the record high of 146.65 yen hit last week.

FED CAMPAIGN FINISHED? The dollar regained its footing after receiving a battering on Friday, when tame U.S. inflation data stirred expectations that the Federal Reserve may have arrived at the end of its two-year campaign of tightening monetary policy.

Market participants were awaiting U.S. economic data this week for clues about whether the Fed has in fact reached the end of its rope after raising rates to 5.25 percent last week.

The Institute for Supply Management's manufacturing index for June is due at 1400 GMT and is expected to come in at 55.0, compared with 54.4 in May.

The week's main event will be non-farm payrolls data for June, due on Friday.

Figures supporting more tightening could boost the dollar, while weaker-than-expected data might suggest the Fed is nearly done with rising rates, weighing on the currency, traders said.

''The data will have to be either very bad or very good to have an impact on the dollar,'' said Waddington at RBS.

REUTERS CS RS1140