FOREX-Yen rallies against dollar, euro after China data
* Yen rises versus dollar, euro as Nikkei tumbles
* Worries Fed may taper QE, weak China PMI hit stocks
* Euro helped somewhat by PMI data, still vulnerable
* Aussie hit hard by weak China data, fall in commodities
NEW YORK, May 23 (Reuters) - The yen advanced sharply 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, entrenching fears that its economic recovery has stalled and that a sharper cooldown may be imminent. [ID:nL3N0E40OA}.
Concerns U.S. monetary stimulus could be scaled back, after testimony on Wednesday by Federal Reserve Chairman Ben Bernanke, added to investor caution and drove Japan's Nikkei share index down 7.3 percent, its biggest one-day drop in two years.
"What we saw was a massive sell off in Japanese equities and a pull back 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, which both 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 101.68, down 1.4 percent on the day.
With the dollar up about 17 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 Fed minutes showed some policymakers were willing to cut bond buying as early as June.
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 131.19, down 1.1 percent.
The single currency was up 0.3 percent at $1.2895, helped slightly by data showing the downturn across euro zone businesses eased slightly this month.
But the euro zone PMI business survey numbers pointed to another contraction in the euro zone in the second quarter. Analysts expected the euro to stay weak against the dollar given concerns the Fed will taper its asset-purchase program while the European Central Bank could ease monetary policy further.
A sharp slide in commodity prices hurt the Australian dollar , along with the Chinese data. China is Australia's biggest export market.
The Aussie last traded down 0.1 percent at $0.9686, recovering from $0.9592, its lowest in nearly a year.