FOREX-Yen surges to seven-month high; dollar drifts ahead of US inflation

Updates with afternoon trading in Europe

By Alun John and Rae Wee

LONDON/SINGAPORE, Sept 7 (Reuters) - The yen surged to a seven-month high on Monday as traders reassessed the battered currency's outlook, driven by expectations of faster Bank of Japan policy tightening and growing bets that Japanese investors could repatriate funds.

The main event this week is Friday's U.S. inflation report, which could shape the Federal Reserve's decision on whether to raise interest rates later this month and influence the dollar's direction.

The European Central Bank also meets on Thursday and is widely expected to raise euro zone interest rates.

Until then, the focus remains on the yen. The dollar fell to as low as 154.05 yen, its weakest level since February, and was last down 1.1% at 154.4. It has now broken below lows reached in August after Washington and Tokyo jointly intervened to support the Japanese currency, which was then trading at 40-year lows. JPY=

Much of the yen's post-intervention gain quickly faded, but fresh support from capital repatriation, unwinding carry trades and U.S. political pressure is prompting investors to rethink long-held bearish positions.

CARRY TRADES

Lee Hardman, senior currency analyst at MUFG, said the dollar's break below 155 yen seemed to have reinforced traders' bullish views on the Japanese currency.

"So far this year, when we have seen the yen strengthen following bouts of intervention, that 155 level was where dollar/yen tended to bottom out. Breaking past that level is a bullish signal and we could see further upside for the yen," he said.

The move has been sharp. The dollar traded above 160 yen as recently as last Tuesday.

Another factor has been the potential unwinding of yen-funded carry trades, which had contributed to the currency's weakness.

Eric Robertsen, global head of research and chief strategist at Standard Chartered, said that while carry trades have been among the strongest-performing macro trades this year despite a surge in borrowing costs globally, the yen's recent rally poses a potential challenge.

"If the JPY were to strengthen persistently, this may signal that the increase in JPY and USD rates is starting to trigger a change in asset allocation," he said.

CPI IN FOCUS

The dollar's slide against the yen also weighed more broadly on the U.S. currency. The euro rose 0.15% to $1.1630 EUR=, while the pound gained a similar amount to $1.3539. GBP=

The dollar faces a crucial week, with traders pricing a roughly 60% chance of a Federal Reserve rate hike this month 0#USDIRPR following Friday's stronger-than-expected U.S. nonfarm payrolls report.

That leaves this week's U.S. inflation data firmly in focus.

"A hot CPI print would all but seal a September hike and underpin a firmer U.S. dollar. A cooler reading would strengthen the case for a hold and leave the U.S. dollar vulnerable to a dovish Fed repricing," said Elias Haddad, global head of markets strategy at BBH.

"Even if a September Fed hike becomes a done deal, we doubt the U.S. dollar will make new cyclical highs. Tightening by other major central banks limits policy divergence."

(Additional reporting by Rae Wee in Singapore. Editing by Alison Williams and Mark Potter)