May 9 (Bloomberg) -- The yen increased against the euro, posting its biggest weekly gain since January, as renewed concern that credit market losses are spreading spurred investors to sell higher-yielding assets.

Japan's currency rose to a three-week high versus the dollar after American International Group Inc. said it needs $12.5 billion to offset subprime writedowns following two consecutive record quarterly losses. The euro extended its advance from an eight-week low against the dollar.

``The market is getting more realistic about the current situation,'' said Matthew Strauss, a senior currency strategist in Toronto at RBC Capital Markets Inc., a unit of Canada's biggest bank by assets. ``The yen will benefit in this environment.''

The yen appreciated 0.2 percent to 159.38 per euro at 4:10 p.m. in New York, from 159.72 yesterday. It increased 0.7 percent to 102.97 per dollar, from 103.74 yesterday, touching 102.62, the strongest level since April 18. The Swiss franc increased 0.9 percent to 1.0416 per dollar and 0.4 percent to 1.6123 versus the euro. The 15-nation currency was up 0.6 percent to $1.5478, from $1.5393 yesterday.

Japan's yen gained 1.9 percent versus the euro and 2.3 percent against the dollar this week as the Standard & Poor's 500 Index dropped 1.8 percent. The euro has increased 6 percent against the dollar this year and 0.3 percent for the week. It has dropped 3.3 percent against the U.S. currency since reaching a record high of $1.6019 on April 22.

U.S. Trade Deficit

The dollar pared its loss versus the euro for most of today after a Commerce Department report showed the U.S. trade deficit narrowed more than forecast in March.

``The longer-term impact from the shrinking trade deficit is positive for the U.S. economy,'' said Camilla Sutton, co-head of currency strategy at Scotia Capital Inc. in Toronto.

Canada's dollar advanced against all of the major currencies after a government report showed employers added more jobs in April than economists forecast. The currency rose for the first time in three days versus the U.S. dollar, increasing 1.2 percent to C$1.0056. The Canadian dollar is up 1.4 percent this week, getting a boost from crude oil prices above $126 a barrel. Commodities account for about half of Canada's exports.

South Korea's won dropped 3.5 percent to 1,044.70 per dollar this week and the Philippine peso fell 0.3 percent to 42.495 on gains in oil and rice prices.

Asia `Vulnerable'

``The Asian economy, which centers on importing raw materials and exporting manufactured products, is vulnerable to higher costs,'' said Yuji Kameoka, a senior economist and currency analyst in Tokyo at Daiwa Institute of Research, a unit of Japan's second-largest brokerage.

The pound posted a third weekly loss against the dollar on speculation the Bank of England will add to three interest-rate cuts since December as the fallout from the collapse of the U.S. subprime-mortgage market hurts the British economy. Sterling fell 0.1 percent to $1.9522 today.

The yen and the Swiss franc strengthened more than 2.5 percent against the South African rand and more than 1 percent versus the New Zealand dollar on speculation AIG's first-quarter net loss of $7.81 billion and a drop in U.S. stocks today discouraged carry trades.

``The escalation of risk aversion has affected demand for carry trades, and that's why we're seeing gains in currencies like the Japanese yen and the Swiss franc,'' said Kamal Sharma, currency strategist in London at JPMorgan Chase & Co.

Carry Trade

In the carry trade, investors get funds in a country with low borrowing costs and invest in one with higher returns. The risk is that currency fluctuations can erase profits. The implied volatility of a one-month dollar-yen option jumped to 13 percent, the highest since late April. Japan's 0.5 percent target lending rate compares with 2.75 percent in Switzerland, 8.25 percent in New Zealand and 11.5 percent in South Africa.

The Standard & Poor's 500 Index dropped 0.7 percent today. It has increased 8.7 percent from March 10, when it reached the lowest since August 2006.

Japan's currency will strengthen to 100 per dollar by the end of June, according to the median forecast of 41 strategists surveyed by Bloomberg News.

The euro rose against the dollar today on speculation the ECB will keep its benchmark rate at a six-year high in coming months to curb inflation pressures.

Inflation in Europe will stay high ``for a rather protracted period,'' European Central Bank President Jean-Claude Trichet said at a press conference yesterday following the ECB's decision to hold its main refinancing rate at 4 percent.

Futures traders have decreased bets that the euro will decline against the U.S. dollar. The difference in the number of wagers by hedge funds and other large speculators on a decline in the euro compared with those on a gain -- so-called net shorts -- was 12,512 on May 6, compared with net shorts of 21,315 a week earlier, figures from the Washington-based Commodity Futures Trading Commission showed.

To contact the reporters on this story: Bo Nielsen in New York at bnielsen4@bloomberg.net; Ye Xie in New York at yxie6@bloomberg.net.

Last Updated: May 9, 2008 16:14 EDT