* Euro off 10-month low after second biggest daily gain this year
* Trade friction worries undermine risk sentiment, prop up yen
* Canadian dollar jumps after BoC revives rate hike expectations
* Japan industrial output disappoints, China PMI upbeat
By Hideyuki Sano
TOKYO, May 31 (Reuters) - The euro won a reprieve on Thursday, holding on to the strong gains it made on Wednesday, as Italian leaders moved to mitigate political turbulence and avoid a potentially disruptive early election.
Italian Prime Minister-designate Carlo Cottarelli said on Wednesday that possibilities had emerged “for the birth of a political government,” suggesting politicians, rather than technocrats like himself, might be able to steer the country out of deadlock.
That has eased fears that fresh Italian elections could strengthen the hand of anti-establishment parties, helping to bring down Italian bond yields after they spiked sharply on Tuesday.
The euro traded little changed at $1.1654, having risen 1.1 percent the previous day, its second-biggest daily gain so far this year. It had hit a 10-month low of $1.1510 on Tuesday.
“I feel Tuesday was a selling climax. The $1.15 level could be a major trough for the euro for the time being,” said a trader at a U.S. bank.
The two-year Italian government bond yield fell to 1.75 percent on Wednesday from 2.71 percent the previous day.
But others remained more cautious.
“As the Italian bond spreads have shrunk, the euro is being bought back. But the situation still looks murky and it is far from certain whether the euro’s recovery becomes full-fledged,” said Naoya Oshikubo, strategist at Barclays.
An underlying theme that has pushed the euro lower since mid-April is a slowdown in Europe and the subsequent retreat in expectations for an early rate hike from the European Central Bank.
The common currency has lost 3.53 percent so far this month, the biggest fall since a 3.57 percent fall in December 2016.
Apart from developments in Italy, investors are also looking to the upcoming euro zone consumer price data at 0900 GMT, which is expected to show inflation has accelerated to 1.6 percent in May.
While the calmer mood around Italy helped to knock the yen off its five-week high hit on Tuesday, many investors are also wary of a potential escalation in trade frictions.
Sources said the United States will announce plans to impose tariffs on steel and aluminium imported from the European Union, affirming a report in the Wall Street Journal.
Negotiations between the United States and China appear to be intensifying as China said on Wednesday it was ready to fight back if Washington was looking for a trade war, days ahead of a planned visit by U.S. Commerce Secretary Wilbur Ross.
China’s warning came after the United States threatened on Tuesday to go ahead with tariffs on $50 billion of imports from China unless Beijing addressed the alleged theft of American intellectual property.
“Last year the world’s trade volume posted strong growth and that drove the globally synchronised growth. But if global trade is to slow down on protectionism, that is going to have a major impact. That possibility should not be ignored,” said Minori Uchida, chief currency strategist at MUFG Bank.
The dollar shed 0.3 percent to 108.60 yen on Thursday morning, edging back towards Tuesday’s five-week low of 108.115 yen. Month-end dollar selling from Japanese exporters is also seen as behind the dollar’s fall, market participants said.
In addition, Japan’s industrial output data was surprisingly weak, putting a damper on risk sentiment and ironically supporting the safe-haven yen.
An official survey on China’s manufacturing sector was more upbeat, but that too has so far failed to change the mood.
The Australian dollar, often used as a proxy on the Chinese economy because of Australia’s dependence on trade with China, dropped 0.2 percent to $0.7565.
Elsewhere the Canadian dollar was firm after the Bank of Canada held interest rates steady but dropped cautious language about future rate moves, signalling that higher borrowing costs could come as soon as its meeting in July.
The Canadian dollar rose 1.1 percent on Wednesday and last traded at C$1.2875 per U.S. dollar, off Tuesday’s ten-week low of C$1.3047 to the dollar. (Editing by Shri Navaratnam and Eric Meijer)