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TOKYO, July 27 (Reuters) The yen hit a three-month high against the dollar and a six-week high versus the euro on Friday as a sell-off in credit and stock markets forced investors to cut back on risky carry trades.

The yen gave up some gains as Japanese investors seized on the rebound to buy foreign assets and higher-yielding currencies at better levels, but traders said further turbulence in financial markets could prompt another wave of short-covering.

The Nikkei share average slid 2.5 percent, tracking a big slide on Wall Street on Thursday as a sharp widening in credit spreads stoked fears that problems in the subprime mortgage market are spreading and could hurt the economy.

''The situation is no longer like that you are OK as long as you are selling the yen,'' said Shuichi Kanehira, senior vice president of Mizuho Corporate Bank.

The yen's broad value has slid to 22-year lows as many market players have used the currency as a cheap source of funds to buy higher-yielding currencies in the carry trade.

The dollar hit a fresh three-month low against the yen at 118.02 yen on electronic trading platform EBS in early Asian trade before recovering to around 118.80 yen as traders took profits on the yen's overnight surge.

Against the yen, the euro fell as low as 162.25 yen the lowest level since mid-June, before rebounding to around 163.30 yen.

The euro stood at $1.3745 steady from late U.S. trade on Thursday and off a record high of $1.3853 hit earlier in the week.

The market shrugged off data showing Japan's core consumer prices dipped 0.1 percent in June from a year earlier, which was in line with economists' consensus forecast.

Investors focused on the market volatility rather than the CPI in cutting the chance of a Bank of Japan interest rate increase next month to about 50 percent from 65 percent the previous day and above 90 percent earlier in the month.

''If anything stops the BOJ, it probably has more to do with financial markets such as the correction seen overnight. We don't think the election really matters for the BOJ unless it triggers more volatility in the markets,'' said Hiroshi Shiraishi, an economist at Lehman Brothers Japan.

An election for half the seats in the upper house of Japan's parliament will be held on Sunday, with the ruling Liberal Democratic Party seen faring poorly due to funding scandals and voter anger over lost pension records.

Polls pointing to a defeat for the ruling camp are stirring talk that Prime Minister Shinzo Abe might be forced to resign, leading to a return to the short-lived governments of the past.

Reuters SBA VP0636