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By Toni Vorobyova
LONDON, Jan 3 (Reuters) - The yen rallied to five week peaks against the euro and dollar on Thursday, boosted by a move to risk aversion as investors worried about the impact of a slowing U.S. economy on global growth and equity markets sold off.
A run of weak U.S. data, including news on Wednesday of contraction in the manufacturing sector in December, has prompted markets to fully price in a 25 basis point Federal Reserve rate cut at the end of the month, and to give a roughly one-in-five chance of a bigger 50 basis point move.
That has sent the dollar to one-month lows versus a basket of major currencies, with losses of 1 percent since the start of 2008 after a fall of 8.4 percent in 2007 -- its worst annual performance in four years.
The yen meanwhile has added around 2.5 percent versus the dollar and 1.5 percent versus the euro in the first few days of January as risk aversion has made investors reluctant to put on carry trade bets funded by cheap borrowing in the low-yielding Japanese currency.
"It's a risk aversion play and the yen seems to be the main benefactor of that. There are still doubts about the outlook U.S. economic activity and equally concerns that in early 2008 we will still have wobbles with regards to sentiment on the banking sector in the U.S.," said Daragh Maher, senior currency strategist at Calyon.
"Equity markets have started off poorly and as a result risk aversion is back in play."
By 1057 GMT the euro had risen to a one-month high of $1.4764 according to Reuters data <EUR=>. The dollar also fell to a one-month low against a basket of major currencies, at 75.797 .DXY.
It was down over 1 percent at 108.53 yen <JPY=>, while the euro was down 0.95 percent at 159.86 yen <EURJPY=>.
Traders said that currency moves were accentuated by relatively thin volumes, as not all market participants have returned from their Christmas and new year holidays as yet.
Some analysts said the absence of yield-seeking outflows from Japan, which is on holiday until Friday, was a factor propping up the yen in the first trading sessions of 2008.
The UBS FX risk index rose to 1.58, suggesting that risk aversion is at its highest in around two weeks thanks to rising volatility in equities and currencies and widening spreads between emerging markets and high-yielders versus safe-haven U.S. Treasuries.
The weak dollar has helped push up oil to around $100 a barrel and gold above $850 an ounce, both fresh record highs, by making crude and bullion cheaper for non-U.S. buyers. The strength in safe-haven gold is also another sign of risk aversion.
The high yielding Australian <AUD=> and New Zealand <NZD=> dollars, which normally suffer as risk aversion spikes, edged lower against the greenback but held up reasonably well as both benefit from strong commodity prices.
The dollar's decline gained momentum on Wednesday after the Institute for Supply Management's index of U.S. factory activity fell to 47.7 in December, marking a contraction that takes the sector closer to levels associated with U.S. recessions.
"A 50 (basis points) point cut by the FOMC at the end of the month is becoming a plausible proposition which will ensure that the dollar remains under selling pressure," BTM-UFJ said in a research note. The Federal Open Market Committe is the Fed's rate setting body.
Fed minutes indicated some policymakers believed tighter credit could require substantial interest rate cuts. However, they also noted financial conditions could improve quickly and force the central bank to reverse those cuts.
Analysts will watch U.S. ADP jobs data at 1315 GMT for clues on the likely outcome of non-farm payrolls on Friday. The ADP report is expected to show that 50,000 new jobs were created in the private sector last month, down from 189,000 in November.
Forecasts ranged widely however, from a job loss of 50,000 to a job gain of 120,000.