* Worries that Fed may taper bond buying hurt stocks
* Weak China PMI drive Nikkei down more than 7 percent
* Yen, Swiss franc rally on safe-haven flows
By Wanfeng Zhou
NEW YORK, May 23 The dollar was on track for its biggest daily drop in more than five weeks against the yen on Thursday after a sharp slide in Japanese stocks and weak Chinese factory activity data prompted a rush for the safe-haven Japanese currency.
The yen also rallied versus the euro and other currencies, further buoyed by a jump in 10-year Japanese government bonds yields, to 1.000 percent, the highest in a year.
China's factory activity shrank for the first time in seven months in May, a survey showed, deepening fears that China's economic recovery has stalled and a sharper cooldown may be imminent.
Concerns that U.S. monetary stimulus could be scaled back, sparked by Federal Reserve Chairman Ben Bernanke's testimony on Wednesday, also weighed on markets and drove Japan's Nikkei share index down 7.3 percent on Thursday, its biggest one-day drop since a slide two years ago in the wake of the tsunami.
"The yen's outperformance Thursday served as a reminder that despite its bearish long-term outlook, it stands to rally when investors turn skittish and need a safer place to hide," said Joe Manimbo, senior market analyst at Western Union Business Solutions in Washington.
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.
"I still think the scope of easing that the government is doing in Japan is going to have an effect and eventually is going to drive dollar/yen higher," said Fabian Eliasson, vice president of currency sales at Mizuho Corporate Bank in New York.
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 101.79 yen, down 1.3 percent for the day, the worst daily performance since mid-April. Some $7 billion in yen changed hands on Thursday on Reuters Dealing, the highest daily volume since at least September.
At the session peak, the yen rose more than 2 percent against the dollar and the euro.
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 131.73 yen, down 0.7 percent.
Against the dollar, the euro zone common currency was up 0.6 percent at $1.2938. 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 17-member bloc 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.
The Swiss franc, another safe haven that has sold off lately, rallied. The dollar fell 1 percent to 0.9682 franc , while the euro lost 0.4 percent to 1.2528 francs .
Some traders said the market's reaction to Bernanke might be short-lived. They focused on Bernanke's caveats that the Fed would need to see more improvements in the economy before reducing stimulus, although the minutes from its 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.