LONDON, Dec 7 (Reuters) - The yen staged its biggest one-day rally in almost a year on Thursday, after Japanese monetary authorities offered a surprisingly clear hint at a shift in policy, while the euro headed for its biggest weekly fall since May.
The dollar index eased ahead of Friday's non-farm payrolls report, under pressure mostly from the yen, which rose by nearly 2% to its strongest in three months.
Bank of Japan Governor Kazuo Ueda said on Thursday the central bank has several options on which interest rates to target once it pulls short-term borrowing costs out of negative territory.
Markets took this as a potential sign that change may be imminent and pushed the yen, which has been punished by speculators taking large bearish positions, higher.
The dollar fell by as much as 1.9% against the yen at one point and was last down 1.5% at 145.135.
"It probably speaks to the positioning that we’ve seen. The market is very, very heavily short the yen and we’ve got a heavy consensus in for 2024 that this is going to be the year that they bring negative rates to an end. So it shows the market is ready to latch on absolutely anything that it can in light of that," TraderX strategist Michael Brown said.
The BOJ has been the lone holdout among central banks, by maintaining a policy of ultra-low rates that sent the yen to its weakest in decades against the dollar and sparked speculation that monetary authorities could intervene to prop up the currency.
Expectations are growing for the BOJ to signal it will soon wind down this policy and next week's meeting may provide that opportunity.
The euro held around three-week lows, fuelled by a dramatic repricing of interest rate expectations for 2024, although caution around Friday's U.S. non-farm payrolls has kept trading volatility subdued.
Falling inflation, a slowdown in major economies such as Germany and softness in the labour market have prompted traders to assume rates will fall to 3.0%, from 4% currently, by September, from an expectation of 3.4% just two weeks ago.
As a result, the euro has hit eight-year lows against the Swiss franc and three-month lows against the pound this week.
The European Central Bank holds its final meeting of 2023 next Thursday. There has been very little resistance from policymakers to the recent repricing of rates, with even known hawk Isabel Schnabel taking rate hikes off the table.
The question of a rate cut could emerge in 2024, ECB member and Bank of France head Francois Villeroy de Galhau told a French paper in an interview published on Wednesday.
Villeroy said that "disinflation is happening more quickly than we thought".
The euro, which has fallen 0.95% this week, was up 0.1% at $1.0775. Against the Swiss franc, it was steady at 0.942 francs, above an earlier low of 0.9404, its weakest since early 2015, when the Swiss National Bank removed its peg between the two currencies.
The dollar index, which shed 3% last month, was down 0.3% at 103.87, not far off a two-week high, with Friday's payrolls the main focus.
Separate U.S. jobs data this week has suggested the labour market is softening, but not showing any material weakness. Futures markets are pricing in a 60% chance of a rate cut by March, up from 50% a week ago, according to the CME's FedWatch tool. But analysts think this might be overdone.
The Canadian dollar was steady against the U.S. currency at 1.3587 after the Bank of Canada on Wednesday held its key overnight rate at 5% and, in contrast to other central banks recently, did not rule out another hike. (Additional reporting by Ankur Banerjee in Singapore Editing by Gerry Doyle, Christina Fincher and Emelia Sithole-Matarise)
