(Bloomberg) -- The euro halted a three-day slide against the yen after a report showed German investor confidence in April increased to the highest level in almost two years.

The euro also rebounded from a five-week low versus the dollar after the ZEW Center for European Economic Research in Mannheim, Germany, said its index of investor and analyst expectations turned positive for the first time in almost two years. Canada’s dollar touched a three-week low against its U.S. counterpart after the nation’s central bank unexpectedly cut its benchmark interest rate to a record-low 0.25 percent.

“We are seeing a reversal of a downward spiral in sentiment,” said Sebastien Galy, a currency strategist at BNP Paribas Securities SA in New York. “An improvement in the ZEW creates a positive loop. It’s consistent with signs of improvement globally.”

The euro rose 1 percent to 127.78 yen at 12:37 p.m. in New York, from 126.48 yen yesterday. It earlier touched 126.09, the lowest since March 16. Against the dollar, the 16-nation European currency rose 0.4 percent to $1.2968, from $1.2921 yesterday, when it touched $1.2889, the weakest since March 16. The U.S. currency rose to 98.55 yen, from 97.89 yen.

The Canadian currency touched C$1.2506, the lowest since April 2, after the central bank reduced the target rate by a quarter percentage point from 0.5 percent, and lowered its forecast for economic growth. The loonie rebounded to C$1.2366 as global stocks gained.

Central Bank Reductions

Thirteen of 25 economists surveyed by Bloomberg News forecast policy makers would leave Canada’s overnight rate unchanged, with the rest calling for a cut to 0.25 percent.

Sweden’s krona gained 1.6 percent to 11.06 per euro after the Riksbank cut the nation’s benchmark interest rate by half a percentage point to 0.5 percent and refrained from buying bonds to revive the economy. Twelve out of 21 economists in a Bloomberg survey forecast the reduction while the rest predicted a bigger cut.

“The markets had definitely priced a more dovish outcome for the meeting,” said Carl Hammer, a senior global macroeconomic analyst in Stockholm at SEB AB.

The euro advanced against the dollar after the ZEW index rose to 13, from minus 3.5 in March. That’s the highest level since June 2007. Economists expected a gain to 2, according to the median of 35 forecasts in a Bloomberg News survey.

“The result would need to be treated with caution,” Geoffrey Yu, a currency strategist in London at UBS AG, wrote in a note to clients today. “The euro is continuing to suffer from risk aversion and expectations of a major change in ECB policy, largely imposed on the central bank by deteriorating internal and external conditions.”

‘Undermine the Euro’

The 16-nation European currency has lost 5 percent against the dollar in the past month on concern European Central Bank policy makers will be struggling to come up with new measures to combat the recession. The ECB next meets May 7.

“There’s a good chance they will disclose the purchase of corporate bonds denominated in euros,” said Michael Woolfolk, a New York-based senior currency strategist at Bank of New York Mellon, said in an interview on Bloomberg Television in Hong Kong. “Such move would likely undermine the euro, and we could see a test around the $1.25 level before the end of May.”

Australia’s dollar rose 2 percent to 71.10 U.S. cents. The currency tumbled as much as 3.8 percent to 69.54 cents yesterday, the lowest since April. 1, on renewed concern that banks will suffer more credit losses. The New Zealand’s dollar advanced 2 percent to 56.34 cents, after losing 2.7 percent yesterday in its biggest decline since Feb. 10.

The two currencies have gained more than 10 percent in the past two months on signs the global economic slump may be slowing.

Banking Losses

Worldwide losses tied to rotten loans and securitized assets may reach $4.1 trillion by the end of 2010 as the recession and credit crisis exact a higher toll on financial institutions, the International Monetary Fund said today.

“We had a huge recovery in the dollar yesterday so there’s bound to be a little bit of consolidation,” said Richard Franulovich, a senior currency strategist at Westpac Banking Corp. in New York. “You are being afforded a free opportunity here to buy your dollars. You’ve had a pretty serious turning point in growth assets.”

The Federal Reserve plans to release results of “stress test” on banks May 4. The tests are being used to determine whether the companies have enough capital to cover losses over the next two years should the recession worsen. Treasury Secretary Timothy Geithner told a congressional panel today that the “vast majority” of U.S. banks have more capital than needed.

‘Risk Capitulation Trade’

“We could be at the start of a larger risk capitulation trade over the next few weeks,” said Brian Dolan, chief currency strategist at FOREX.com, a unit of online currency trading firm Gain Capital Group in Bedminster, New Jersey. “The banks have no clothes and they’re about to be exposed.”

The yen snapped three days of gains against the euro and the dollar before a government report tomorrow that may show Japan had a trade deficit of 27 billion yen ($275 million) in March, according to a Bloomberg News survey of economists.

“There’s a sense the yen has been overbought,” said Toshihiko Sakai, head of trading for foreign exchange and financial products in Tokyo at Mitsubishi UFJ Trust & Banking Corp., a unit of Japan’s largest bank. “Market participants are probably unwinding long yen positions.” A long position is a bet an asset will gain.

To contact the reporters on this story: Ye Xie in New York at yxie6@bloomberg.net; Oliver Biggadike in New York at obiggadike@bloomberg.net