Aug. 2 (Bloomberg) -- The yen may strengthen to 116 per dollar in three months as Japanese individual investors reduce sales, according to Deutsche Securities.

Japan's lowest overnight lending rate among major economies has prompted domestic investors to seek higher-yielding assets overseas, pushing the yen to a 4 1/2-year low against the dollar in June. The yen became the best performer among the 16 most- active currencies in the past month as U.S. mortgage losses fueled risk aversion, discouraging Japan's retail traders from buying currencies such as Australian and New Zealand dollars.

``They won't exercise much power to stem the yen's appreciation this time around,'' said Koji Fukaya, senior currency strategist in Tokyo at Deutsche Securities. ``Japanese retail traders are largely taking a wait-and-see attitude amid concern over U.S. subprime issues.''

The yen climbed to 118.75 against the dollar at 9 a.m. in London compared with 118.96 in late New York yesterday, when it reached 117.60, the strongest since April 2. It also advanced to 162.22 per euro from 162.58 yesterday, when the rally reached 160.47, the highest since April 24.

The yen also advanced against the Australian and New Zealand dollars, popular carry trade currencies. Australia's dollar fell to 101.39 yen from 101.80 yen, and New Zealand's dollar slid to 90.76 yen from 91.15 yen.

Japanese pensioners, businessmen and housewives have taken advantage of the Bank of Japan's 0.5 percent benchmark rate to borrow yen to buy higher-yielding currencies. The growing popularity of so-called carry trades added to declines in the yen, which dropped against all 16 major currencies in the past year.

Lesson Learned

Yen short positions by Japanese investors, bets the currency will weaken, dropped to $24.3 billion yesterday, from $24.9 billion a week earlier, according to Bloomberg calculations based on the Tokyo Financial Exchange. Japanese investors have 1,536 trillion yen ($12.9 trillion) in savings, according to figures from the Bank of Japan.

Japan's overnight rate is 7.75 percentage points less than New Zealand's and 3.50 percentage points below that of the European Central Bank.

When the carry trade collapsed in 1998 following Russia's debt default, the yen jumped 10 percent against the dollar in two days and ended the year 15 percent higher. The biggest challenge to the strategy this year came when Chinese stocks slumped on Feb. 27, prompting fund managers to cut riskier investments and pay back yen loans. The yen rose 2.3 percent in a single day, the biggest gain since July 2005.

``Japanese retail investors got a lesson in February and are taking yen rallies very coolly,'' said Tatsuo Owada, vice president of the corporate planning department in Tokyo at NTT Smart Trade Inc., a foreign-exchange margin trading company with 3,300 accounts. ``They did not lose much money this time. They had decided to sell the dollar at a certain fixed level before the dollar fell a lot, and they did.''

To contact the reporter on this story: Kosuke Goto in Tokyo at at kgoto2@bloomberg.net.

Last Updated: August 2, 2007 04:10 EDT