LONDON : The yen rose sharply on Tuesday after the Bank of Japan refrained from additional measures to curb recent bond market volatility, sparking a steep drop in Japanese equity futures. The Japanese currency gained more than 2 percent to hit 96.48 yen per dollar after the BOJ held off from extending the maximum duration of its fixed-rate loans to two years from one as some expected. This prompted investors to unwind some of their hefty bets against the yen placed after the BOJ announced aggressive stimulus in early April.

It also pushed Japanese equity futures , with which dollar/yen has been closely correlated in recent weeks, down 2 percent.

But the broad trend for yen weakness in coming months was expected to remain while the dollar was seen strengthening due to the prospect of the U.S. Federal Reserve reducing stimulus.

More yen gains could see the dollar drop towards 95.96 yen, the bottom of the daily Ichimoku cloud - a closely followed technical indicator - and Friday’s low of 94.975 yen.

“We are in a period of correction for the Abenomics trade of higher equities and a weaker yen ... We view this as a temporary correction and would look for levels around 95 to buy dollar/yen,” said Lee Hardman, currency economist at BTMU, referring to the stimulus policies of Japan’s Prime Minister Shinzo Abe.

A slide in emerging market and higher-yielding currencies added to yen gains because many of these investments were funded in yen, Hardman said.

One-month dollar/yen implied volatility traded near its highest in more than a year at around 15 percent.

“The yen has reacted (to the BOJ) but we are fairly neutral about dollar/yen in the short term given there is so much volatility,” said Chris Walker, currency strategist at Barclays.

The euro fell nearly 2 percent to 128.19 yen. It rose 0.1 percent to $1.3269, near last week’s 3-month peak of $1.3306, helped after Germany’s Economy Ministry said the economy picked up in the second quarter.

But euro gains were checked by rising peripheral bond yields as Germany’s Constitutional Court started a two-day hearing on the legality of the European Central Bank’s bond-buying scheme that has defused the euro zone debt crisis.

A ruling is not expected until after German general elections in September, but investors were nervous Bundesbank chief Jens Weidmann, who will attend the court hearing, could reiterate his opposition to the ECB programme.

The higher-yielding Australian dollar slid sharply to hit its lowest since September 2010 at $0.9325.