LONDON, Dec 22 (Reuters) - The yen firmed on Thursday, returning towards a four-month peak against the dollar hit this week after an unexpected tweak to the Bank of Japan's bond yield controls spurred bullish yen bets.
The yen rose about 0.4% to 131.99 per dollar. It had surged to a four-month high of 130.58 on Tuesday after the BOJ decided to allow the 10-year bond yield to move 50 basis points either side of its 0% target, wider than the previous 25 basis point band.
The greenback, which moved broadly lower after rising 0.6% against the yen in the previous session, had failed to meaningfully recoup the 3.8% slump that followed Tuesday's news.
"The yen has significant room to appreciate from here...," said Michael Brown, analyst at Trader X.
"I think dollar-yen has scope to move back towards the mid-120s, around 125 or 126, as the BOJ becomes more hawkish, and also as markets continue to doubt what we're hearing from the Fed," Brown added.
Against the euro, the yen steadied at 140.56, while trading at 159.61 per pound. The yen was close to its strongest against both currencies since late September.
The dollar softened due to a pickup in risk sentiment after data on Wednesday showed U.S. consumer confidence rose to an eight-month high in December, as inflation retreated and the labour market remained strong.
"The consumer confidence figures suggested the economy is holding up in the face of higher interest rates," said Equiti Capital head macro economist Stuart Cole, adding that positive earnings from Nike were also helping.
"We are seeing hopes rise that we may yet get the much hoped for soft U.S. landing. That is good for risk sentiment," Cole added.
The dollar index, which measures it against a basket of six currencies including the yen, fell as much as 0.5% to 103.75, its lowest level in a week.
The euro was 0.4% higher at $1.0649 as more ECB policymakers came out in support of further rate hikes.
Sterling rose 0.2% to $1.2109, partially reversing Wednesday's 0.85% fall.
Britain's economy contracted in the third quarter by a little more than first estimated and business investment performed poorly, the Office for National Statistics said on Thursday.
"The UK outlook remains pretty dismal and there are no clear reasons why you would necessarily want to be long of sterling," Equiti Capital's Cole said, although he expected some support as the BoE further tightens policy.
"I can easily see sterling being somewhat of a backwater currency going forward, with little reason to buy or sell it, unless of course we get some unexpected event."
In Asia, the Chinese offshore yuan was marginally higher at 6.9828 per dollar, although sentiment remains weighed down by the spread of COVID-19 across the country.
(Reporting by Samuel Indyk and Rae Wee; Editing by Edmund Klamann and John Stonestreet)
