Feb. 28 (Bloomberg) -- The yen declined from a 10-week high against the dollar, after the biggest increase yesterday since July 2005, as reports showing slackening growth encouraged investors to sell the currency to buy higher-yielding assets.

Japanese reports showing a drop in industrial production and retail sales may prompt the Bank of Japan to refrain from raising interest rates from 0.5 percent, the lowest in the industrialized world. The dollar pared its gains after U.S. data showed new-home sales declined and a gauge of business activity contracted.

``The BOJ is still dovish and they won't raise interest rates rapidly,'' said Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York. ``Investors are still willing to short the yen.'' A short position is a bet on a currency's decline.

The yen fell to 118.19 per dollar at 10:28 a.m. in New York from 117.93 yesterday. It surged 2.3 percent yesterday as a slump in global equities caused fund managers to pare riskier investments funded with the currency. Against the euro, the yen was at 156.07 from 156.17.

The dollar pared gains against the euro and yen after new- home sales in the U.S. fell last month by the most in 13 years to an annual rate of 937,000. The National Association of Purchasing Management-Chicago said its business barometer fell to 47.9 this month from 48.8 in January.

Gross Domestic Product

Gross domestic product, the sum of all goods and services produced in the U.S., grew at an annual pace of 2.2 percent in the fourth quarter, compared with a previous estimate of 3.5 percent reported on Jan. 31, and a 2 percent pace in the third quarter, the Commerce Department said in Washington.

The dollar traded at $1.3208 per euro from $1.3242 yesterday, after earlier touching an intra-day high of $1.3181.

Japan's yen fell after the government said factory output in January fell a seasonally adjusted 1.5 percent, from a gain of 0.9 percent the previous month, and retail sales declined 0.8 percent from a year earlier.

``Japanese industrial production and retail trade disappoint,'' said Antje Praefcke, a currency strategist at Commerzbank AG in Frankfurt. ``The overall economic picture for Japan hasn't changed and we would expect the yen to weaken again.''

Bank of Japan board member Atsushi Mizuno said expectations for low interest rates contribute to yen carry trades and it's important to continue to normalize borrowing costs. He said rates need to keep rising. Central bank Governor Toshihiko Fukui told lawmakers in Tokyo the bank's rate increase last week won't harm growth.

Carry Trade

The carry trade involves borrowing the currency of a nation with low interest rates and investing to obtain higher yields elsewhere. Borrowing costs are 5.25 percent in the U.S. and U.K.

China's stocks rebounded after a sell-off in that market yesterday triggered a global tumble in equities, while most Asian and European markets fell a second day. U.S. stock markets rose after the biggest plunge in the country's equities in four years yesterday.

Volatility on one-week yen options on the dollar jumped to as high as 10.6 percent, the highest since June, before trading at 9.1 percent. Implied volatility, a gauge of expected swings in exchange rates, is quoted as part of setting option prices.

``The spike in the yen and currency volatility will provide a dent in the confidence of investing in carry trades in as large a size,'' said John Kyriakopoulos, a currency strategist at National Australia Bank Ltd. in Sydney. ``It's an issue of whether there's some contagion.''

To contact the reporters on this story: Min Zeng in New York at mzeng2@bloomberg.net; Aaron Pan in London at apan8@bloomberg.net.

Last Updated: February 28, 2007 10:31 EST