NEW YORK (CNNfn) - The U.S. dollar fell to a 7-1/2-month low against the Japanese yen Wednesday as investors exchanged the dollar and investments denominated in it for other currencies that appear to have more upside potential.
At 2:30 p.m. Eastern time, the U.S. currency was trading at 108.85 yen, down close to 1 percent in value from Tuesday's close of 109.76. That's the lowest the dollar's been against the yen since it touched 108.62 yen Jan. 12. Aside from January, the dollar hasn't slipped below 109 yen since August 1996.
The dollar has been in almost steady decline since touching a peak of 124.75 yen in mid-May, despite two interest-rate increases from the Federal Reserve and further evidence of robust economic growth.
That's because investors are looking abroad to Japan and parts of Europe with renewed optimism about the economic outlook in those regions, something that eventually would lead to higher interest rates abroad and better returns on their investments than they're getting in the U.S.
Higher rates tend to make the currency and securities denominated in it more attractive.
"There is a common theme that economic fortunes look brighter in Japan and continental Europe than they do in the U.S.," said William Sullivan, senior vice president of money market research with Morgan Stanley Dean Witter. "Even though higher rates should help the currency, they haven't because most people are seeing that as the Fed's move to slow the economy and reduce growth."
Rising rates aren't helping
Fed policy makers have raised interest rates twice in the past two months in an effort to curb U.S. growth and douse the consumer-led economic boom that they expect may begin to push up consumer prices. The Fed most recently raised its benchmark fed funds rate by a quarter point to 5.25 percent Aug. 24.
Normally, rising interest rates help boost the value of the currency as investors scanning the globe for good returns choose the U.S. over other countries. In Canada, for example, the benchmark interest rate rests at 4.75 percent, about half a point lower than what's offered in the U.S.
However, after nine years of virtually uninterrupted expansion, investors are increasingly convinced the U.S. economy will slow, and that further U.S. rate increases, if they occur, will ensure that. That's why many of them now are looking beyond U.S. borders, selling their greenbacks and buying yen and euros, analysts said.
"A lot of money is moving toward assets that are at very cheap prices in Japan,'' said Jeff Cheah, an analyst with Standard & Poor's MMS. "That flow of funds is creating a demand for yen and pushing the U.S. dollar's value lower."
The euro was little changed at $1.0583 compared with $1.0566 late yesterday. The euro earlier reached as high as $1.0640, its strongest since $1.0678 on Aug. 23.
While the U.S. dollar isn't expected to rebound to its springtime highs against the yen, its performance against other currencies, particularly those of secondary economies in Asia and Latin America, is still quite strong, indicating the U.S. dollar's drop against the yen isn't necessarily a sign of weakness, Sullivan said. The Thai baht, for example, hit an 11-month low against the dollar Wednesday.
More intervention on the way?
What's more, a stronger yen could have longer-term consequences for the Japanese economy as prices on goods such as cars and electronics rise. That could work to slow growth, something the Japanese government wants to avoid after being mired in recession for the past decade.
"What is clear is that Japan does not really want a strong yen," Cheah said. "If the currency gets too strong it might stall the growth momentum we've seen coming out of Japan."
That's why there's a strong possibility the Bank of Japan will intervene in financial markets again to slow down the appreciation of their currency, Sullivan said. "They may wait until after their second-quarter (gross domestic product) report comes out because if the number is strong, trying to slow down the yen will be an uphill battle."
In the past, the Bank of Japan has sent signals to financial markets by selling yen in attempt to weaken its value. 
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