(Updates prices, adds quote and comment, changes byline)
* Citi merger talk, equity rebound prompt FX turnaround
* Sterling also rises as risk aversion cools
* Weak euro zone PMI a reminder of economic distress
* For up-to-the-minute market news, click on FXNEWS (Updates prices, adds comments, changes byline, dateline)
By Steven C. Johnson
NEW YORK, Nov 21 (Reuters) - The dollar and yen fell on Friday as global stocks rebounded and reports that banking giant Citigroup was mulling a merger with another firm helped quell market anxiety.
The more relaxed mood prompted those who had lately sold risky assets in favor of the U.S. and Japanese currencies to reverse course and move back gingerly into stocks, commodities and higher-yielding currencies such as the euro and sterling.
"It feels like we've reached a point where total fear is receding a little. There's an inkling of hope that we may be near a bottom, which is reflected in equities and high-yielding currencies today," said Boris Schlossberg, senior currency strategist at GFT Forex in New York.
Geoffrey Yu, currency strategist at UBS in London, said "the market is trying to be optimistic but not get carried away."
Early in New York, the euro was up 0.9 percent at $1.2575
Asian and European shares also rose and Wall Street opened on a firm footing, lifted partly by news that Citigroup (C.N: Quote, Profile, Research, Stock Buzz), which lost half its market value this week, was considering selling parts of its business or merging with another company.
Citigroup's board of directors is scheduled to meet on Friday to discuss options, the Wall Street Journal reported, citing people familiar with the situation. For details, see [ID:nN20470744]
Worries about the future of Citigroup on Thursday had pushed the bank's shares to their lowest in more than a decade, helping drive the S&P 500 index to its weakest point since 1997.
But while the reports about Citi on Friday eased some concern about another major bank failure, some said it would not be enough to improve lending conditions and pull markets out of their malaise.
Analysts at Brown Brothers Harriman said both the euro and sterling are overbought and are ripe for a reversal before the day is through, as neither has been able to move above key resistance levels of $1.2660 and $1.51, respectively.
Schlossberg said the test will be whether investors feel confident enough to remain long U.S. equities and higher risk currencies such as the euro and sterling through the weekend.
"If you see people buying equities into the close today, that will be euro and sterling positive, but if stocks sell off in late trade, currencies will react and the dollar and yen should benefit," he said.
Earlier, euro zone data showed the manufacturing and service sectors contracting much more quickly and deeply than expected in November, rekindling worries about global growth.
The weaker-than-expected PMI survey "likely will feed the recession fears gripping markets and pose more downside for risk assets," JP Morgan currency strategists said in a note.
The yen was mostly a victim of renewed risk appetite on Friday, though it also buckled when Finance Minster Shoichi Nakagawa said authorities must be ready to deal with market price swings [ID:nTKG003105]. Analysts said investors saw that as a warning that Japan could still step in to slow yen gains.
(Additional reporting by Naomi Tajitsu in London; Editing by Chizu Nomiyama)
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