By Stanley White
TOKYO (Reuters) - The yen held near a three-week low on Tuesday as pared expectations for aggressive Federal Reserve cuts supported the dollar and ahead of a Bank of Japan meeting, which is seen as a key test for policymakers amid a global monetary easing cycle.
The BOJ is expected to keep monetary policy on hold at a meeting ending later on Tuesday, but some investors say there is a chance Japan's central bank could change its forward guidance to reassure traders that rates will remain low.
Against a basket of six major currencies, the dollar traded near a two-month high. The U.S. Fed is expected to cut rates by 25 basis points on Wednesday, but this is more likely to be a one-off than the first in a series of several rate cuts.
The pound hit a new 28-month low early in Asia trade as investors grew increasingly nervous about the prospects of a no-deal Brexit under new British Prime Minister Boris Johnson.
Monetary policy is likely to set the tone for currency markets in coming months as central banks from Australia, New Zealand, Europe and possibly Britain are expected to cut rates due to low inflation and risks to global economic growth.
"The BOJ may not have much influence on the currency market because of their limited policy options," said Junichi Ishikawa, senior foreign exchange strategist at IG Securities in Tokyo.
"We need to focus on how the Fed views the U.S. economic outlook, because Fed Reserver Chairman Jerome Powell is still optimistic about the economy. This could lead to a bounce in yields and the dollar."
The yen was quoted at 108.835 per dollar, close to a three-week low of 108.900 reached on Monday.
The market consensus is for the BOJ to maintain a pledge to guide short-term interest rates at -0.1% and the 10-year bond yield around 0% via aggressive bond purchases.
Some investors, however, see a possibility the BOJ may tweak its forward guidance and commit to keeping rates ultra-low over a longer-term horizon.
Currently, the BOJ commits to maintaining rates at current extremely low levels "for an extended period of time, at least through around spring 2020".
The BOJ's decision is expected 0300-0500 GMT.
The dollar index (DXY) was little changed at 98.074, near a two-month high of 98.165.
The Fed is forecast to cut its target interest rate range on Wednesday by 25 basis points to 2.00%-2.25%.
Investors previously saw the chance of an even more aggressive 50-basis point cut, according to interest rate swaps, but these expectations have dissipated as data has shown the U.S. economy is not as weak as some feared.
Sterling briefly slipped to $1.2209, the lowest since March 2017.
There is a growing risk of a no-deal Brexit where Britain exits the European Union without a trade deal in place. There is also a chance that new Prime Minister Johnson will call an early election.