The report showed that the headline diffusion index for large manufacturing firms rose to plus 10, exceeding economists' consensus, spurring an initial bout of yen strength.

But a closer look revealed a widening of the gap between larger manufacturers, which can benefit from global growth through exports, and smaller companies, which mainly rely on domestic demand, analysts said. In addition to concern over an apparent two-speed economy in Japan, there was also cautiousness over the outlook for the coming months, they added."The report shows that recovery in Japan is moving along fairly nicely," said Mr Steven Saywell, currency analyst at Fuji Bank in London.

"But there's still this divergence, this two-speed economy. That's why even though we've got a stronger headline, the reaction is a slight downward revision for the outlook of the Japanese economy, hence a weakening of the yen."

The dollar rose to a six-week high of 109.00 yen early in Europe, according to Reuters data, bouncing back from lows around 108.50/60 it had hit after the Tankan release. It stood at 108.80 by 0945 GMT. Analysts said the yen was put under further pressure after Thomson Financial BankWatch said it had downgraded its sovereign risk rating outlook for Japan to negative from stable, although it left the rating itself at "AAA".

The move follows a rating downgrade by the influential rating agency Moody's Investors Service last month.

Dealers said dollar/yen was also assisted higher by the end of repatriation flows linked to the end of Japan's fiscal first-half last Friday and reduced pressure on Japanese firms' euro/yen exposures due to the euro's recent rebound.

Meanwhile the dollar was retaining an upper hand against the euro in the absence of central bank intervention. But traders said wariness that the Group of Seven would repeat their joint euro-supported action on September 22 had not faded.

By 0945 GMT, the euro stood at $0.8763/65, nearly a cent under Monday's peaks but not far from late Monday levels. "The euro is still dependent on G7 support," said Mr Neil MacKinnon, senior currency strategist at Merrill Lynch in London. "But if we start slipping back into the $0.8650-0.8700 area, I think the G7 will repeat their intervention and I think the market is alert to that."

Euro zone August unemployment data are due at 1000 GMT. Analysts said the market was starting to focus on the outcome of this week's policy-setting meetings in the US, Euro zone and Britain.

The US will kick start the string of meetings later in the day, when the Federal Open Market Committee meets. A decision on rates is expected at 1815 GMT.

All 29 primary dealers polled by Reuters said they expected the Fed to keep interest rates steady. Therefore, analysts said, dealers would concentrate on the accompanying statement.

"In its last statement the Fed was still highlighting the inflationary threat to the US economy," said Mr Saywell at Fuji.

"If we do see a softening of that tone, an acknowledgment that the economy is slowing and may be an acknowledgment also that corporate profitability is not as firm as it was in the last quarter, that could lead the market to believe that there is less chance of another Fed rate hike going forward."

There was off-and-on talk of a possible European Central Bank monetary tightening at its policy meeting on Thursday. But traders said even such a move was unlikely to make the euro any more attractive as higher rates could harm euro zone growth. "The main focus is that the ECB may hike rates and intervene soon afterwards," said Mr Fabio Fraschetti, currency strategist at BNL in London.

"The ECB needs to bring euro/dollar above $0.90. They have managed to stabilise the euro, but in the current range it is still looking vulnerable."Finally, the Bank of England Monetary Policy Committee will meet on rates on Wednesday and Thursday.