By Jemima Kelly
LONDON (Reuters) - The dollar buckled against the yen on Friday as tensions simmered on the Korean peninsula, though the sharp divergence between U.S. and Japanese monetary policy kept the greenback on track for a winning week against the yen.
North Korea said on Friday it might test a hydrogen bomb over the Pacific Ocean after U.S. President Donald Trump said he would destroy the country if it threatened the United States or its allies.
Adding to investors' risk-aversion was S&P Global Ratings' downgrade to China's sovereign credit rating. On Friday, the ratings agency said the country's attempts to reduce risks from its rapid buildup in debt are not working as quickly as expected and credit growth is still too fast.
The dollar dropped as much as 0.8 percent to 111.65 yen
The yen tends to benefit during times of crisis due to Japan's net creditor nation status, and the expectation that Japanese investors would repatriate assets.
"Many are questioning whether that can remain the case in the presence of a risk event that is local to Japan," wrote RBC Capital Markets analysts in a note to clients.
"We find near-perfect symmetry in the way the yen responds to Asia-specific shocks and shocks from elsewhere, suggesting it can (remain a safe haven)," they added.
For the week, the dollar was still up more than 1 percent against the yen, having scaled a two-month peak of 112.725 after the U.S. Federal Reserve signaled that it was still on track to raise interest rates by the end of the year, and after the Bank of Japan maintained its bond-buying pledge.
The dollar index, which tracks the U.S. unit against a basket of six major rivals, fell 0.3 percent to 92.024 (DXY), but it was still slightly higher on the week and was well above its more than 2-1/2 year trough of 91.011 marked on Sept. 8.
It surged to its strongest in 15 days on Wednesday, but has since slipped around 1 percent.
"If traders were hoping for a strong U.S. dollar rebound in the wake of this week's Fed meeting, the initial response was certainly encouraging (but) beyond that the response has been underwhelming," said CMC Markets analyst Michael Hewson.
"Even if the Federal Reserve were able to deliver on a December rate rise, there is so much uncertainty about what the FOMC (Federal Open Market Committee) will look like in six months’ time...that any projections for three further rate rises in 2018 have to be treated with a huge amount of caution."
The euro climbed half a percent to $1.1992 <EUR=> and was also up 0.1 percent for the week, with traders not seeing Sunday's German elections as a risk. Chancellor Angela Merkel is widely expected to win a fourth term in power.