LONDON, Mar 5 The yen rose nearly two percent on the day against the euro on Monday and e

LONDON, Mar 5 (Reuters) The yen rose nearly two percent on the day against the euro on Monday and extended a rally to a three-month high versus the dollar as edgy investors unloaded risky carry trades in the face of tumbling stock markets.

Yen strength against major currencies, which saw it register its biggest weekly percentage gain versus sterling since November 1999 last week, has fuelled market volatility and investor anxiety as they rush to cut their exposure to risk.

Tokyo stocks posted their biggest one-day fall in nine months on Monday while Chinese stocks, which triggered a global sell-off last week, dropped 4 percent at one point.

European shares were down around 2 percent while U.S.

futures were pointing to a lower open on Wall Street later.

Falling stocks, along with concern about the U.S. economy, are prompting nervous investors to liquidate carry trades where they sold the low-yielding yen to buy higher-return assets.

''Risk reduction is taking place and price action is feeding itself,'' said Adarsh Sinha, currency strategist at Barclays Capital.

''It seems to have started in equities last week. Given that positions on carry trades are very large, it could continue for some time... (or) it's like trying to catch a falling knife.'' By 1050 GMT the euro fell as low as 151.22 yen, its lowest since late November and down 1.8 percent on the day.

The euro saw its biggest weekly percentage losses against the yen last week since August 2003, having hit a record high near 160 in February.

The dollar hit a three-month trough of 115.16 yen, before coming back to 115.27, down 1.3 percent on the day.

The yen hit a 21-year low in January on a real, inflation-adjusted traded weighted basis.

The single currency's big losses against the yen dragged it down half a percent to $1.3125. The euro was unmoved by below-consensus euro zone service sector data.

Sterling took the biggest hit from carry unwinding, dropping more than 2 percent at one point to 221.51 yen -- last seen in mid-October.

The pound had been one of the biggest beneficiaries of the carry trade financed by the yen or Swiss franc.

But unwinding of short-yen positions has seen sterling shed around 8 percent from a 14-year high struck in January. Sterling also fell 1 percent to $1.9216.

VOLATILITY SOARS One-month dollar/yen implied volatility hit 10.35 percent, its highest since June when similar risk aversion sent the yen higher. Rising volatility prompts investors to cut back carry trades as the fluctuation in currencies can easily wipe out gains from yield differentials.

Analysts also said the yen's fresh move higher was partly triggered by the Chicago Mercantile Exchange's move last week to lift the minimum amount of money required to trade yen futures due to higher market volatility.

The CME lifted margin amounts by 25 percent for futures in the yen against the Australian dollar, the euro and sterling.

Analysts say the carry unwind has further to run as investors around the world reprice risks.

''The current re-pricing of risk is a phenomenon that will be with us - on and off - for much of the first half of 2007,'' HBOS Treasury markets in a note to clients.

''At its root is the dawning realisation that the probability of a continuation of the goldilocks scenario of strong growth and low inflation is low.'' The bank added the trade-off between growth and inflation is much less favourable than at any point since the early 1990's.

Investors were on alert for possible comments on market conditions from Japanese finance minister Koji Omi later on Monday after his meeting with U.S. Treasury Secretary Henry Paulson in Tokyo.

''From a G7 perspective the move lower in euro/yen would be very welcome -- the question from the Ministry of Finance point of view is when does this become a disorderly move,'' said Kamal Sharma, currency strategist at Bank of America.

Investors were also awaiting speeches from Federal Reserve officials later in the day. Further ahead, the focus is on U.S.

data including the February jobs report, to see if the figures provide any more reason to expect the Fed to cut interest rates, which could spark more dollar selling.

REUTERS CS DS1657