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By Vivianne Rodrigues
NEW YORK, Aug 2 (Reuters) - The dollar rose against the yen for a second straight day on Thursday as traders took advantage of a rebound in U.S. blue-chip stocks to adjust positions before Friday's closely-watched payrolls report.
The euro and sterling traded higher even as the European Central Bank and the Bank of England left rates on hold at 4 percent and 5.75 percent, respectively.
Traders said the respite from the recent sharp swings in financial markets prompted a return to selling low-yielding currencies such as the yen and Swiss franc to buy higher-yielding but riskier assets.
"The trade this week has been simple: if stocks rise, you short the yen, if they fall, you buy back yen," said Gregory Salvaggio, a senior currency trader at Tempus Consulting in Washington. "But the payrolls report tomorrow may break this pattern, making the forex market less dependent on stocks to asses risk."
By late afternoon trading, the dollar was up 0.3 percent against the yen at 119.16, recovering from four-month lows the previous day <JPY=EBS>. The euro also rose 0.5 percent to 163.26 yen <EURJPY=>.
ECB President Jean-Claude Trichet said after the bank's policy meeting that "strong vigilance" was needed to stem inflation risks, signaling a possible September rate hike.
The euro hit session highs earlier around $1.3706 <EUR=> after Bundesbank President Axel Weber said fears of a German banking crisis were unfounded following problems at IKB (IKBG.DE: Quote, Profile, Research).
In a statement, Weber said problems at IKB, which specializes in lending to small- and mid-sized companies, were of an "institution-specific nature."
IKB has become Europe's most high-profile casualty so far of the crisis in the U.S. subprime mortgage market. Its problems have fueled concerns that other German banks might be in trouble.
"Risk aversion is going to remain high. Because people have lost a lot of money, I don't think they're going to put a lot of risk back into the market," said Rafael Martorell, chief dealer at BNP Paribas, in New York.
Against the Swiss franc, the dollar was little changed at 1.2031 francs <CHF=>.
Last week's sell-off in the stock market and a slide in corporate bond prices over the past few weeks caused hefty losses for some banks and hedge funds. For currency traders, this has sparked a reversal of risky carry trades where cheap borrowing in the yen is used to fund purchases of high-yielding currencies such as the Australian dollar.
The unwinding of carry trades has come in fits and starts, reflecting the market's heightened nervousness about the extent of problems in the U.S. housing and credit sectors.
By late afternoon in New York, the high-yielding New Zealand dollar was up 0.7 percent at 91.54 yen <NZDJPY=R> while the Australian dollar was up 0.4 percent at 102.20 yen <AUDJPY=R>.
Wall Street stock indexes -- among the hardest hit markets -- have found their footing over the last 24 hours, riding late day rallies to end higher for the second consecutive session on Thursday.
The ECB's Trichet weighed in on the recent volatility in financial markets. He said the central bank was closely monitoring shifts in sentiment and the price movements that were part of a "normalization of pricing risk."
David Powell, senior currency strategist at IDEAglobal in New York, said Trichet did not seem to express concern about the current state of markets.
"To me, his remarks on 'normalization of risk' implies that the current volatility will not affect the ECB's tightening campaign," Powell said. (Additional reporting by Gertrude Chavez-Dreyfuss)