Sept. 26 (Bloomberg) -- The yen rose against the dollar and posted its biggest weekly gain since May as U.S. lawmakers disagreed over a financial rescue and Washington Mutual Inc. became the nation's biggest bank to collapse.

Japan's currency also strengthened against the euro and the Brazilian real after a group of Republicans opposed to the Treasury's $700 billion asset-purchase plan submitted an alternative proposal, prompting investors to reduce holdings of higher-yielding assets funded in Japan.

``The risk-aversion trade is back on, but it's not huge,'' said Alan Ruskin, head of international currency strategy in North America at RBS Greenwich Capital Markets Inc. in Greenwich, Connecticut. ``You never know what the next headline will be. The talk is that they will eventually pass the package in some shape or form.''

The yen rose 0.4 percent to 106.18 per dollar at 4:07 p.m. in New York, from 106.56 yesterday, extending this week's gain to 1.2 percent. The yen increased 0.4 percent to 155.14 per euro, from 155.68, and was up 0.2 percent for the week. The dollar traded at $1.4610 per euro, compared with $1.4609. It has depreciated 1 percent since Sept. 19.

President George W. Bush said in a statement today that Congress will overcome any disagreement and approve a financial rescue, while Alabama Senator Richard Shelby, the top Republican on the Banking Committee, said he's willing to let U.S. stock markets open Monday without an agreement.

Stronger Yen

The yen gained 1.9 percent to 57.43 versus the real today and 1 percent to 88.15 against the Australian dollar on speculation investors will exit trades in which they get funds in a country with low borrowing costs and buy assets where returns are higher. Japan's 0.5 percent target lending rate compares with 4.25 percent in Europe, 7 percent in Australia and 13.75 percent in Brazil.

``Safe-haven trades are back on,'' said Shaun Osborne, chief currency strategist at TD Securities Inc. in Toronto. ``No one is committed to big positions.''

Goldman Sachs Group Inc. recommended today that its clients buy the real, Mexico's peso, Turkey's lira and the Aussie against the dollar, saying the bailout may bolster demand for higher yields.

``We see potential for a significant rally if market conditions start to normalize,'' New York-based Goldman currency strategist Jens Nordvig and colleagues wrote in a research note.

The real declined 1.9 percent to 1.8554 per dollar today and was headed for a 12 percent drop this month, the biggest among the most-active currencies. The Aussie fell 0.5 percent to 83.08 U.S. cents and was down 3.1 percent in September.

Unclear on Bailout

Currency traders are reluctant to put on big bets because it's unclear when Congress will pass the bailout, according to Paresh Upadhyaya, who helps manage $50 billion in currency assets as a Boston-based senior vice president at Putnam Investments.

``These are not the right times to be putting on any bold trades because it's the perfect environment for getting whipsawed,'' said Upadhyaya. ``I think waiting on the sidelines is probably the most prudent thing to do.''

After reaching a one-year low of $1.3882 on Sept. 11, the euro has traded in a range of $1.4437 to $1.4866 this week. It reached the all-time high of $1.6038 on July 15.

Futures contracts on the Chicago Board of Trade showed traders were certain the Fed would reduce the 2 percent target rate for overnight lending between banks by Oct. 29. There's a 66 percent chance policy makers will cut by a quarter-percentage point and 34 percent odds of a half-point decrease. Traders priced in a 68 percent likelihood of no change a week ago.

Economic Growth

The U.S. economy expanded at an annual rate of 2.8 percent in the second quarter, slower than the previous estimate, the Commerce Department said today. Reports showed yesterday sales of new homes fell in August to a 17-year low and orders for durable goods dropped more than forecast.

``The economy is slowing, and an interest-rate reduction will take its toll on the dollar, said RBS's Ruskin. ``We are in an early stage of a downturn, which will last for many, many months.''

Government regulators seized Seattle-based WaMu, which faced $19 billion of mortgage-related losses, after customers withdrew $16.7 billion since Sept. 15. JPMorgan Chase & Co. agreed to acquire WaMu's deposits and branches for $1.9 billion.

The yen may rise further as the VIX volatility index, a Chicago Board Options Exchange gauge reflecting expectations of stock market price changes, closed above 30 for the past nine days, indicating markets are facing a shock comparable to the 1997 Asian currency crisis and the Sept. 11, 2001, terrorist attacks, according to JPMorgan Chase.

Japan's currency has increased 2.5 percent versus the dollar in September, the first monthly gain since March. Against the euro, Japan's currency has advanced 3 percent. The dollar is up 0.4 percent versus the euro this month.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Daniel Kruger in New York at dkruger1@bloomberg.net

Last Updated: September 26, 2008 16:15 EDT