FOREX-Yen drops to two-week lows as confidence grows

* Yen takes a hit as optimism about global economy grows

* Data from China, South Korea support risk appetite

* Investors wary about U.S. banks' stress test results

By Anirban Nag

SYDNEY, May 1 (Reuters) - The yen fell to two-week lows against the U.S. dollar and the euro on Friday as investors grew confident that the pace of global economic decline was abating, boosting appetite for riskier assets.

Trading was thin, with much of Asia, except Japan, headed out for the May Day holiday. The yen JPY= was also hurt by data which showed Japan reporting a drop in core consumer prices, putting the country in its second round of deflation in less than two years, while the jobless rate hit a 4-year high. [nT308650].

Still, data from other regional powerhouses seemed to support the view that the worst for the global economy might be over. Chinese manufacturing gained momentum last month while South Korean exports fell by less than expected. [nSEO286684] [nPEK279290].

That optimism supported stock markets with Tokyo's Nikkei .N225 trading in positive territory on Friday, after ending up nearly 4 percent higher a day earlier.

"This confidence is spreading in the equity markets and risk appetite is growing more and more. As a result the yen is sold broadly," said Toru Umemoto, chief FX strategist Japan at Barclays Capital in Tokyo. "Investors are seeking a growth gap and a rate gap and as a result the yen is a funding currency."

The dollar rose to as high as 99.16 yen JPY= from 98.60 in New York on Thursday, before paring some of those gains. The euro rose to around 131.50 yen EURJPY=, its highest since April 16, before easing back to 131.06 yen.

The Aussie also headed back towards its recent peaks on the yen, rising to 71.88 yen AUDJPY=R, not far from Thursday's high of 72.56 yen.

Risk appetite has been boosted by string of better global economic data nTOPMACRO and a note of optimism from the U.S. Federal Reserve earlier this week. Encouraging U.S. employment and manufacturing data on Thursday have added to a burgeoning sense of optimism.

ISM DATA AWAITED

The influential U.S. ISM report is due late in the day and is expected to show an improvement after reports showed that business activity in the U.S. Midwest contracted at a much less severe rate in April.

"Investors are looking for signs of economic stability across the globe," said Jonathan Cavenagh, currency strategist at Westpac, Sydney. "Any signs that data is better or in line with expectations could lift risk appetite and high-yielding currencies like the Aussie and the kiwi."

The Aussie AUD=D4 jumped 5 percent against the U.S. dollar in April, rising to a seven-month high of $0.7384k on Thursday. The greenback fell 5.2 percent on the Canadian dollar CAD=, its the biggest monthly drop since September, 2007.

The euro EUR= was at $1.3251, off a two-week high of $1.3384, with gains capped by uncertainty about whether the European Central Bank will opt to follow the Federal Reserve and embrace unorthodox policy measures such as buying securities to stimulate growth.

So far investors are concentrating on signs of green shoots in the global economy, but sentiment remains vulnerable to jitters over a H1N1 flu virus breakout as Mexico began shutting down parts of its economy to slow the spread of the virus. nFLU

Even news that U.S. automaker Chrysler has filed for bankruptcy on Thursday failed to have much of an impact on currency markets.

But, analysts said, there would be a degree of caution ahead of next week's release of the stress test results of individual U.S. banks. [nN30527288]

"Currency investors will be wary of taking huge positions ahead of those results," said Westpac's Cavenagh. If banks fail the stress test and need additional capital, risk appetite could take a beating and currencies like the Aussie and the New Zealand dollar could drop.

(editing by Wayne Cole)