FOREX-Yen rallies sharply against dollar, euro after China data
* Yen rises versus dollar, euro as Nikkei tumbles
* Worries that Fed may taper QE, weak China PMI hit stocks
* Euro helped somewhat by PMI data, still vulnerable
* Aussie hit hard by weak China data, falling commodity prices
NEW YORK, May 23 (Reuters) - The yen broke recent trends and jumped against the dollar and the euro on Thursday after a slide in stocks sparked by a drop in Chinese factory activity prompted a rush for the safe-haven Japanese currency.
China's factory activity shrank for the first time in seven months in May as new orders fell, a preliminary manufacturing survey showed, deepening fears that its economic recovery has stalled and a sharper cooldown may be imminent. [ID:nL3N0E40OA}.
Concerns that U.S. monetary stimulus could be scaled back, after testimony on Wednesday by Federal Reserve Chairman Ben Bernanke, added to investors' caution and drove Japan's Nikkei share index down 7.3 percent, its biggest one-day drop since the period two years ago in the wake of the tsunami that disrupted the Japanese economy in March 2011.
"What we saw was a massive selloff in Japanese equities and a pullback in risk with the yen being the biggest beneficiary," said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington, D.C., but "a lot of the drivers are still in place, and we are likely to see the dollar push higher and the yen push lower."
At the session peak, the yen rose more than 2 percent against the dollar and the euro. Both the greenback and the euro lost 1 percent against the Swiss franc , also seen as a safe haven.
The yen hit a two-week high of 100.82 to the dollar, reversing a slide to a 4-1/2-year low of 103.73 yen on Wednesday after Bernanke told Congress the Fed could "in the next few meetings take a step down" in its bond buying.
The dollar was last at 101.63 yen, down 1.5 percent for the day, with the session's swing between the low of 100.82 yen and the peak of 103.56 yen. Some US$6.891 billion in yen changed hands on Thursday on Reuters Dealing, the highest daily volume since at least September.
With the dollar up about 17.2 percent against the yen this year, analysts said the Chinese data and the drop in stocks provided the excuse for a profit-taking correction.
"The market got overextended in terms of bullishness on dollar/yen yesterday after the Bernanke comments. We now have seen a correction and some uncertainty in the JGB (Japanese government bond) markets," said Jeremy Stretch, head of currency strategy at CIBC World Markets in London.
"The market was somewhat overbought and this prompted a fairly aggressive reaction (in dollar/yen) which was overlayed by a pretty seismic move in equities as well."
Analysts said the dollar could drop further against the yen if stocks continued to decline. But they expected the trend of yen weakness and dollar strength to remain given aggressive easing in Japan and the prospect of tighter U.S. policy.
"The correction (in dollar/yen) has the potential to go further ... But there is no risk of a dramatic fall and any move below 100 should be brief," said Niels Christensen, currency strategist at Nordea in Copenhagen.
Some traders focused on Bernanke's caveats that the central bank would need to see more improvements in the economy before reducing stimulus, even though the minutes from the Fed's most recent meeting showed some policymakers were willing to cut bond buying as early as June.
James Bullard, president of the Federal Reserve Bank of St. Louis, said on Thursday that he did not think the Fed was "that close" to starting the process of winding down its support although it was the likely next step if the economy continued to improve and inflation picks up.
The euro slid to a two-week low of 129.94 yen, having touched a 3 1/2-year peak of 133.77 yen on Wednesday. It was last at 131.26 yen, down 1 percent.
Against the dollar, the single currency was up 0.5 percent at $1.2915. The euro got a modest lift from data showing the downturn across euro-zone businesses eased slightly this month.
But the numbers in the euro-zone PMI business survey pointed to another contraction in the euro zone in the second quarter. Analysts expected the euro to stay weak against the dollar, given concerns that the Fed will taper its asset-purchase program while the European Central Bank could ease monetary policy further.