The yen had slumped on Friday, setting two-month lows versus the dollar and giving up around 1.5 per cent against the euro, on a combination of concern about the health of Japan's economy and talk of an impending downgrade of Japan's credit rating by US rating agency Moody's.

On Monday Tokyo's Nikkei stock index dropped 1.57 per cent, extending Friday's losses amid fears that more Japanese corporate bankruptcies would unfold, particularly among heavily indebted construction companies.

"After the big move on Friday people are taking a bit of profit on dollar/yen," said a dealer at a Japanese bank in London. "But the market is very wary of pushing the yen too high."

By 0725 GMT dollar/yen was hovering at day's lows around 108.70, down more than half a yen from peaks above 109.15 it set on Friday.

Euro/yen was struggling around 101.60 yen against 101.91 in late New York trade on Friday, but it was still up from the three-week lows around 99.20 seen last week. "The overall sentiment on the yen remains bearish," said Mike Moran, treasury economist at Standard Chartered in London.

"Although the recovery in Japan is ticking over nicely,there are sectors of the economy which are still too weak to justify a strong recovery in the yen."

Dealers reported scant reaction to comments from Bank of Japan (BoJ) governor Masaru Hayami, who reiterated on Monday that the economy was improving enough to bear a rise in interest rates. The market increasingly expects the BoJ to end its longstanding zero-rate policy at the August 11 meeting of its policy board, though many worried that such a move would not benefit the yen given the brittle state of foreign confidence in Japan.

"There was a time not that long ago when a hike would have been seen as a vote of confidence in the economy, but not any more," said a US bank dealer in Tokyo. "Now if the BoJ tightens, investors will worry that it'll derail the recovery, but if they don't they'll worry that the bank daren't because the economy can no longer stand it."

Meanwhile euro/dollar was resting quietly around $0.9350 following last week's bounce from key support at $0.92. The euro was holding ground against the dollar after the announcement of that US Wireless group Voice Stream had agreed to a $50.7 billion cash-and-stock takeover by German telecommunication giant Deutsche Telekom AG.

-- (Reuters)