* G7 says market must set currency rates
* G7 says domestic policies must not aim to weaken currencies
* Japan content with statement
* But G7 official says statement was aimed at yen levels
By Mike Peacock and Anna Yukhananov
LONDON/WASHINGTON, Feb 12 (Reuters) - The Group of Seven rich nations sought on Tuesday to cool growing tension over exchange rates sparked by weakness in the Japanese yen, but currency markets found the effort lacking in clarity, triggering a second straight day of volatility.
The G7 declared that fiscal and monetary policies would not be directed at devaluing currencies, a statement meant to soothe nerves that Tokyo was aiming to guide the yen lower with its aggressive expansion of monetary policy.
Japan said the statement gave it a green light to continue efforts to reflate its economy but a G7 official said it was aimed squarely at Tokyo, prompting the yen to surge.
"Rather than calm the markets, the poorly communicated statement has significantly raised volatility," said Richard Gilhooly, fixed-income strategist at TD Securities in New York.
U.S. and European officials have been concerned about comments from Japanese officials that suggested Tokyo was targeting a specific level for the yen, which would run counter to the G7's official stance.
A day earlier, a senior U.S. official said competitive devaluations should be avoided, but that Washington supported Tokyo's efforts to reinvigorate growth and end deflation. The remark sent the yen sharply lower.
The G7 statement helped the yen solidify those losses, until a G7 official said markets had gotten the message wrong.
"The G7 statement signalled concern about excess moves in the yen," the official said. "The G7 is concerned about unilateral guidance on the yen. Japan will be in the spotlight at the G20 in Moscow this weekend."
This sent the value of the yen rushing the other way from 94.28 yen before the comment to a session low of 92.96 after it. By late afternoon in the United States, it was trading at about 93.5.
G20 finance ministers and central bankers meet in Moscow on Friday and Saturday. Some have previously pointed out that the United States has adopted similar policies to Japan.
EYES ON THE G20
The G7 powers - the United States, Britain, France, Germany, Japan, Canada and Italy - earlier on Tuesday had reiterated their commitment to market-determined exchange rates and said they would consult closely to avoid disorderly and volatile market moves that could hurt economic and financial stability.
"We reaffirm that our fiscal and monetary policies have been and will remain oriented towards meeting our respective domestic objectives using domestic instruments, and that we will not target exchange rates," the rich nations group said.
Japanese Finance Minister Taro Aso said the statement was a recognition that Tokyo's policy steps were not aimed at affecting foreign exchange markets.
"It was meaningful for us as (the G7) properly recognises that steps we are taking to beat deflation are not aimed at influencing currency markets," Aso told reporters.
Bank of Canada chief Mark Carney said the G7 needed to use the weekend meetings of the larger G20, which groups together both advanced and emerging nations, to urge developing countries to adopt flexible exchange rates.
"It's important that we as a G7 go in united and forcefully to the G20 to enlarge that commitment as quickly as possible," he told a Canadian parliamentary committee.
Separately, the Swiss National Bank reiterated its determination to keep a lid on the strong franc, rejected charges it was contributing to a currency war, and said it expected the franc to keep weakening.
WORDS NOT ACTIONS
Last week, France went as far as calling for a medium-term target to be set for the euro out of concern the exchange rate had become too strong. Berlin rejected that suggestion.
French Finance Minister Pierre Moscovici made little headway at a meeting of euro zone finance ministers on Monday although Germany's finance minister did sound a note of concern.
"There's no foreign exchange problem in Europe," Wolfgang Schaeuble told reporters at the end of a European Union finance ministers meeting in Brussels. "There are concerns that there could be something like this in other parts of the world."
Since late last year, the euro has climbed more than 10 cents from below $1.27. It has eased in recent days after European Central Bank chief Mario Draghi indulged in a bit of gentle verbal intervention, saying he would monitor the impact of a strengthening currency.
Draghi took pains to play down the issue on Tuesday, telling reporters in Madrid: "I think the term 'currency wars' is way, way over done. We are not witnessing anything like that."
The U.S. Federal Reserve and the Bank of Japan are expanding their balance sheets rapidly by printing money, while the ECB's balance sheet is tightening, partly due to banks paying back cheap money the central bank doled out last year.
All else being equal, that could drive the euro yet higher, the last thing a struggling euro zone economy needs.
Any pain will be just as acute in emerging markets which have suffered before from an inflow of hot money, seeking higher yields and destabilizing their economies.
Brazilian Finance Minister Guido Mantega told Reuters last week that the situation could get even worse if Europe joined the currency fray.