FOREX-Yen, dollar stung as stocks regain footing

(Updates prices, adds quote and comment, changes byline)

* Citi merger talk, equity rebound prompt FX turnaround

* Sterling, Aussie and NZ dlrs rise as risk aversion cools

* Weak EZ PMI a reminder of economic, financial distress

By Naomi Tajitsu

LONDON, Nov 21 (Reuters) - The dollar and the yen fell sharply against higher-yielding currencies on Friday as a rebound in global stocks from the previous day's rout prompted some investors to creep back into riskier assets.

European shares managed to stay in positive territory, taking a lead from gains in Asian stocks, while talk that beleaguered U.S. bank Citigroup (C.N: Quote, Profile, Research, Stock Buzz) could explore a merger deal helped to quell Thursday's extreme risk aversion.

Analysts said Friday's move was a correction of yen- and dollar-buying earlier in the week, when investors dumped risky assets, including those in euros, sterling and the Australian and New Zealand dollars, on concerns about a global recession and the ongoing financial crisis.

"It's a 'three steps back, one step forward' move today," said Geoffrey Yu, currency strategist at UBS in London, adding that traders were adjusting positions in higher yielders following three days of heavy selling.

"The market is trying to be optimistic, but not get carried away."

Despite a slight lift in risk aversion, market participants pointed out that surprisingly weak purchasing managers indices from the euro zone on Friday offered a reminder that the euro zone's recession may be more severe than thought.

The euro traded 1.0 percent higher at $1.2589 by 1218 GMT, after climbing as high as $1.2624 in early trade. The euro was boosted by a 0.6 percent rise in European shares .FTEU3, while U.S. stock futures pointed to a higher market open.

Stocks rebounded, as investors were cautiously optimistic that Citigroup, which has lost half of its market value this week, is weighing various options including selling part of the company or merging with another firm [ID:nN20470744]

Worries about the future of Citigroup on Thursday helped to push the S&P 500 index to its lowest point since 1997.

YEN STRUGGLES

The euro climbed nearly 2 percent against the yen to 119.40 yen, bouncing back from a three-week low around 116.45 yen hit according to Reuters data in Asia very early in the day.

The dollar was up 0.8 percent on the day at 94.82 yen , recovering from a three-week low of 93.55 yen struck early in Asia.

The yen was on the back foot after investors took comments from Japanese Finance Minister Shoichi Nakagawa that authorities must be ready to deal with big market swings [ID:nTKG003105] as a reminder that Japan will step in to stem the yen's rise if needed.

There was little reaction to the Bank of Japan's widely expected move to hold rates at 0.30 percent. [ID:nT14410]

The Australian and New Zealand dollars were both up roughly 2 percent against the greenback and 3 percent versus the yen, while sterling jumped as much as around 2 percent to a session high of $1.5060 .

The Swiss franc remained under pressure a day after the Swiss National Bank stunned markets with a surprise interest rate cut of 100 basis points. The dollar rose as high as 1.2298 francs, its strongest level since June 2007.

The economic fragility that prompted the SNB's aggressive move was also highlighted on Friday by a report that showed euro zone manufacturing and service sectors contracting much more quickly and deeply than expected in November.

The flash purchasing managers' indices tumbled to record lows and also showed that inflationary pressures in the 15-nation currency bloc were fading fast. [ID:nLAG003116].

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. (Editing by Stephen Nisbet)

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