Yen gains as carry trades reversed on stock slide

TOKYO, May 25 (Reuters) The yen jumped on Friday, pulling away from a three-month low against the dollar struck earlier in the week, as investors reversed short positions in the Japanese currency on a sharp drop in regional stock markets.

Japan's broad TOPIX share index fell 1.6 percent and other Asian markets lost nearly 1 percent following a pull-back in Wall Street shares, stirring worries about a rise in financial market volatility that hurts carry trades.

Market players have widely borrowed the low-yielding yen to fund purchases of higher-yielding currencies and assets in the carry trade, helping lift sterling to a 15-year peak against the yen and the euro to an all-time high this week.

Analysts said investors may also be taking profits on winning positions before a long three-day weekend in much of Europe and the United States, where markets will be closed on Monday.

''Ahead of the long weekend, there may be some adjustments.

May is kind of a position adjustment season as we saw last year,'' said Masafumi Yamamoto, currency strategist at Nikko Citigroup in Tokyo.

The move also came as traders triggered automatic sell orders in both the dollar and euro versus the yen, exacerbating the drop, traders said.

The dollar fell 0.3 percent to 120.95 yen pulling back from a three-month peak of 121.88 yen earlier in the week.

The euro fell 0.4 percent to 162.30 yen reversing from this week's all-time peak at 164.03 yen hit on Wednesday.

The single currency drop's against the yen dragged it down to a six-week low versus the dollar at $1.3411 before clawing back to near $1.3420 ''It's very much a euro/yen driven move,'' said a senior FX trader at a European bank in Hong Kong.

JAPAN CPI FALL SLOWS The market shrugged off data showing Japan's core inflation fell at a slower pace in April, reinforcing expectations the Bank of Japan will lift rates in coming months.

Japan's core consumer price index matched forecasts with a 0.1 percent fall in April from a year earlier after declining by 0.3 percent in March, suggesting inflation is slowly returning towards positive territory.

''The figures were not surprising, so the yen buying was a delayed reaction to the fall in U.S. stocks on risk concerns,'' said a trader at a Japanese bank.

With Japan's steady expansion seen in good shape, expectations have mounted for the BOJ to lift rates to a 12-year high of 0.75 percent from the current 0.5 percent in August or September following parliamentary elections in July.

BOJ Governor Toshihiko Fukui has said the central bank could raise rates even if inflation is still in negative territory as long as the long-term outlook for prices to rise remains in place.

But the yen has suffered despite the prospects for a BOJ rate increase as Japan's very low yields compared with those in the United States and euro zone have spurred carry trades and prompted Japanese investors to seek better returns in foreign assets.

''Even if the BOJ hikes rates earlier, other central banks are also raising rates like the UK and Australia,'' said Yamamoto at Nikko Citigroup. ''That might be why even if the BOJ hikes rates, the conditions for the yen carry trade are not changing very much.'' The dollar gained on Thursday on data showing U.S. new home sales rose at the fastest pace in 14 years, stirring more doubts about whether the Federal Reserve would need to cut rates later this year and undermine the dollar's yield advantage.

REUTERS SR VV1101