March 5 (Bloomberg) -- The yen approached a three-year high against the dollar as speculation that banks will have to write off more mortgage-related debt led investors to pare carry-trade bets funded with loans in Japan.

Japan's currency reached its strongest level of the day yesterday after Federal Reserve Chairman Ben S. Bernanke urged banks to forgive more mortgage loans. The currency then retreated as U.S. stocks trimmed losses after CNBC reported that a deal with New York to bail out bond insurer Ambac Financial Group Inc. is proceeding. The dollar traded close to a record low versus the euro as traders bet the Fed will reduce rates by 0.75 percentage point to 2.25 percent this month.

``The primary driver is still risk aversion,'' said Michael Malpede, a senior currency analyst in Chicago at MF Global Research, part of MF Global Ltd., the world's largest broker of exchange-traded futures and options contracts. ``That's strengthening the yen.''

The yen traded at 103.36 per dollar at 7 a.m. in Tokyo. It reached 102.66 yen in New York trading yesterday, close to the 102.62 yen level from March 3 that was the strongest since Jan. 28, 2005. The yen pared its rise as stocks recovered from the weakest levels of the day. It traded at 157.18 per euro. The dollar traded at $1.5214 per euro, from $1.5204 on March 3, when it touched $1.5275, the weakest since the euro's 1999 debut.

Bernanke, battling a housing recession, said ``principal reductions that restore some equity for the homeowner may be a relatively more effective means of avoiding delinquency and foreclosure.'' He spoke to bankers in Orlando, Florida.

Banks' Losses

U.S. banks face ``challenging market conditions'' that will likely hurt earnings and consumer lending, Fed Vice Chairman Donald Kohn told lawmakers yesterday.

Since the start of 2007, more than 45 of the world's biggest banks and securities firms have taken about $181 billion in asset writedowns and credit losses, including reserves set aside for bad loans. The Standard & Poor's 500 index fell 0.3 percent, paring a drop of as much as 1.8 percent.

Two-year Treasury yields touched 1.495 percent yesterday, and are about 1.5 percentage points below German two-year debt. Futures on the Chicago Board of Trade show most traders expect a 0.75 percentage point Fed cut at the bank's March 18 meeting.

We're seeing ``U.S. yields falling very steeply versus other industrialized country yields, and that's really the problem for the dollar,'' Daniel Katzive, a currency strategist at Credit Suisse Group, said on Bloomberg TV. ``If our yields are at a significant disadvantage versus other industrial countries the dollar's going to suffer.''

Bank of Canada

The U.S. Dollar Index traded on ICE Futures in New York was at 73.664 after falling to a record low of 73.354 on March 3. The slump in the U.S. currency helped push the price of oil to a record of $103.95 this week and gold to an all-time high of $989.54 an ounce.

The Canadian dollar fell to 99.38 Canadian cents per U.S. dollar, from 99 cents the day before, after the central bank cut Canada's benchmark rate by a half-point to 3.5 percent and said further ``stimulus'' will likely be required.

Japan's currency also climbed 1.4 percent to 95.88 per Australian dollar and 0.8 percent to 82.79 per New Zealand dollar as widening credit-market losses prompted investors to reduce so-called carry trades

The rate cut by Canada's central bank is ``a signal that the global central banks may be more cautious in terms of the global economic outlook,'' said Steve Butler, a director of currency trading at Scotia Capital Inc. in Toronto. ``The mighty U.S. is slumping, and that will take its toll on global growth.''

Europe's Concern

Japan's benchmark rate of 0.5 percent, the lowest among industrialized nations, compares with 8.25 percent in New Zealand and 4 percent in the euro region. In carry trades, investors get funds in a country with low borrowing costs and invest in one with higher rates, earning the difference between the two. The risk is that currency moves erase those profits.

``It's clear that we look at exchange-rate developments very closely and with some concern,'' Austrian Finance Minister Wilhelm Molterer said in Brussels yesterday.

While the Fed has cut borrowing costs five times to 3 percent since September, the ECB has kept its key rate at a more than six-year high of 4 percent to curb inflation even as economic growth slows.

For central banks to support the dollar against the euro ``we would need to have as a very minimum a collective decision'' in the Group of Seven, and that won't happen unless the pace of the dollar's decline increases, Michael Woolfolk, a senior currency strategist at the Bank of New York Mellon Corp. in New York, said on Bloomberg TV. The G-7 comprises the U.S., Japan, Germany, the U.K., France, Canada and the U.K.

To contact the reporters on this story: Bo Nielsen in New York at bnielsen4@bloomberg.net

Last Updated: March 4, 2008 17:09 EST