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By Gertrude Chavez-Dreyfuss
NEW YORK, Dec 21 (Reuters) - The dollar climbed to six-week peaks against the yen on Friday as investors waded back into carry trades amid a rally in U.S. stocks, but the greenback slipped versus the euro on profit-taking after recent gains.
U.S. stocks rose sharply, as strong earnings from Research in Motion boosted the technology sector and news of a an overseas investment in brokerage giant Merrill Lynch (MER.N: Quote, Profile, Research) supported financial shares.
A Wall Street Journal report of a possible $5 billion capital infusion for Merrill by Singapore state investor Temasek Holdings helped ease concerns about risk, which have been fueled by the troubles in the U.S. subprime mortgage sector. The move prompted investors to sell the low-yielding yen again and buy high-yielding units in carry trades.
"U.S. stocks are doing well well, so we're seeing a rally in dollar/yen and the return of carry trades," said Rafael Martorell, chief FX dealer at BNP Paribas in New York.
"I do see stocks rising after the New Year because I think all the bad news has already been priced in. We have broken 113.80 yen on the upside and if U.S. stocks continue to rally, then I see no reason why dollar/yen could not hit 115, 115.50," he added.
The dollar surged to a 1-1/2-month peak of 114.16 yen <JPY=> and last traded at 114.01, up 0.8 percent on the day. The euro rose to a one-week high at 163.94 yen, but traded back down to 163.63 yen <EURJPY=>.
Volumes, however, were thin, with most traders winding down for the year.
Shaun Osborne, chief currency strategist at TD Securities in Toronto, said dollar/yen is likely to push higher, but said the pair's momentum would probably be unsustainable, given an erosion of real returns with rising U.S. inflation pressures.
The euro <EUR=> was up 0.2 percent against the dollar at $1.4354 <EUR=>, pushing away from a two-month low of $1.4308 touched on Thursday. It also benefited from its surge against the yen.
Analysts said overall the Merrill Lynch report helped restore some confidence in the financial sector, which has been battered by multibillion-dollar write-downs of assets linked to subprime mortgages.
"That Merrill Lynch report has further underscored that there is investment out there and that funding for many of these institutions is available and is likely to produce a soft landing (for the U.S.) next year and there is no reason or panic just yet," said Michael Woolfolk, currency strategist at Bank of New York Mellon.
The improvement in the risk environment boosted high- yielding currencies such as the Australian<AUD=> and New Zealand dollars <NZD=>. The Aussie surged 0.8 percent to US$0.8650, while the Kiwi dollar gained half a percent to US$0.7631.
Sterling hit an all-time low against the euro <EURGBP=> on expectations that UK interest rates may be cut as soon as next month. The euro rose as high as 72.56 pence, according to Reuters data, but traded down to 72.42.
The pound was slightly down against the dollar at $1.9820 <GBP=>.
Earlier, the dollar was little moved by reports showing a jump in U.S. personal spending and a late December sentiment index that was near its lowest level since the aftermath of Hurricane Katrina in 2005. For details, see [ID:nN21255598].
There was also no reaction to results of the Federal Reserve's $20 billion, 35-day Term Auction Facility. (Additional reporting by Lucia Mutikani; Editing by Leslie Adler)