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LONDON, Feb 24 (Reuters) The yen hit one-month highs against the dollar and euro on Friday, extending a rally made after comments from the Bank of Japan's governor signalled Japanese interest rates are set to rise.

BOJ Governor Toshihiko Fukui said on Friday conditions for a policy shift were falling into place, following up his upbeat remarks on Thursday which sent the yen higher by one percent.

Adding fuel to the yen's gains was a report in Japan's Yomiuri newspaper on Friday that the BOJ was considering the possibility of dismantling its policy of flooding the money market with excess funds -- quantitative easing -- as early as its March 8-9 meeting.

''The yen move has been pretty frantic but there is not particularly a new story -- the drift towards the end to quantitative easing is playing as a yen positive,'' said Daragh Maher, senior currency strategist at Calyon.

''The drift out of high-yielders is also playing in favour of the yen.'' The yen hit one-month highs of 116.43 per dollar but eased to 116.85 by 1255 GMT (1825 IST), up a quarter per cent from the U.S. close.

The yen was trading at 139.05 per euro, near earlier one-month highs of 138.76 and a gain of nearly half a per cent on the day.

The euro was down nearly a quarter per cent at $1.1896, in the $1.18-23 range which has held since December.

Implied volatility of one-month euro/dollar options hit fresh 3-year lows, which traders said reflected the lack of movement in the euro/dollar spot market.

GOODS DATA U.S. durable goods data at 1330 GMT (1900 IST) are seen down one percent in January after a 1.8 per cent rise in the pervious month.

''We are expecting a reasonably soft number, which could undo some small dollar gains we have seen against European currencies,'' said Maher.

Speakers later in the session include Federal Reserve chief Ben Bernanke, U.S. Treasury Secretary John Snow and European Central Bank officials Jean-Claude Trichet, Lorenzo Bini Smaghi and Otmar Issing.

EURO ZONE RATES A preliminary estimate of German consumer price inflation came in at 0.4 per cent on the month and 2.1 per cent on the year in February, close to consensus forecasts and the previous month's figures.

Analysts polled by Reuters this week expected the European Central Bank to raise rates by a quarter point to 2.50 per cent next week, following a quarter point rise in December.

''The (inflation) numbers are consistent with expectations for continued ECB tightening,'' said UBS analysts in a client note.

The Swiss franc briefly hit the day's highs against the euro after Switzerland's KOF leading indicator of business expectations rose to 1.30 in February from an upwardly-revised 1.26 in January, beating expectations.

JAPAN, U.S. RATES Some in the market took Fukui's comments on Thursday that the central bank would ''eventually move step by step to a neutral interest rate level'' as a signal the BOJ could begin raising rates sooner than expected.

Reflecting rising expectations for a policy change, short-term Japanese bond yields shot to five-year highs on Friday. Futures markets are fully pricing in a quarter percentage point rate rise by September.

Many in the market expect U.S. overnight rates to rise to 5 per cent by mid-year from 4.5 per cent at the moment, continuing the Fed's steady credit tightening that began in mid-2004.

''The dollar's interest rate story has run its course as the market has priced in 5 per cent. After the middle of the year, the market will start discounting a first cut, or a pause by the Fed,'' said Adam Cole, senior currency strategist at Royal Bank of Canada.

''That's why the (currency) market has been so rangebound.'' REUTERS SD

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