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By Jamie McGeever
LONDON, Aug 15 (Reuters) - The yen jumped to a 4-1/2-month high against major currencies on Wednesday as tumbling equities and persistent worries about credit markets prompted investors to slash exposure to riskier carry trade positions.
The dollar, sterling, euro and Australian and New Zealand dollars all fell to their weakest levels since late March/early April against the yen as investors continued to cut long positions in currencies with attractive yields as financial market turmoil continued to bubble.
The low-yielding Japanese currency has been widely used as a cheap source of funds to buy higher-yielding currencies in so-called carry trades.
Canada's main rating agency DBRS warned on Tuesday of possible defaults in the C$116 billion ($109 billion) market for asset-backed commercial paper as one issuer said it couldn't repay paper that is due and a mortgage lender said its profits could be hurt.
The yen's rally resulted in a surge in implied volatility on yen currency options, a sign the unwinding of positions has caught investors wrong-footed and is forcing them to pay more for protection against further sharp price moves.
The dollar, meanwhile, continued to benefit from the broad market distress, with the 'flight to liquidity' lifting the greenback's value against a basket of major currencies to its highest in six weeks.
"The de-leveraging story is starting to spread to more markets," said Laura Ambroseno, currency strategist at Morgan Stanley in London.
"We're at important levels, we've had big moves over the last few weeks," she said, referring to sterling's break below $2.00, the euro's fall below $1.35 and the gradual approach of 115.00 yen per dollar.
At 1010 GMT the dollar was down 0.7 percent on the day against the yen at 116.70 yen, near its session low of 116.62 yen <JPY=>, according to Reuters data. The euro was down 1 percent at 157.45 yen <EURJPY=R> after hitting a low of 157.22 yen.
The New Zealand dollar was down 2.2 percent at 83.48 yen <NZDJPY=R> and the Aussie tumbled 1.9 percent to 96.15 yen <AUDJPY=R>.
The euro was down a third of a percent on the day at $1.3490 <EUR=>, having earlier fallen to $1.3476 -- its lowest since late June.
The euro slipped to a six-week low against the dollar, as investors fretted about European exposure to the problematic U.S. subprime mortgage sector -- raising speculation that the European Central Bank may not lift interest rates next month.
Sterling, already reeling from much weaker-than-expected UK inflation data on Tuesday, fell below $1.99 <GBP=> to a low of $1.9868. Surprisingly weak UK average earnings growth data kept it under pressure.
Risk aversion spread rapidly through equity markets, with European shares lower in morning trading after a sharp decline on Wall Street sparked a selloff in Asian shares. The Nikkei fell more than 2 percent to its lowest in more than eight months (.N225: Quote, Profile, Research).
The flip side of this was a rally in European government bonds.
"There's been wave after wave of bad news ... and a continuation of the trend of ongoing risk reduction. There's uncertainty and no-one knows how much further this will go or how bad the situation is," said Martin McMahon, FX strategist at Credit Suisse.
Next on the data front is U.S. consumer price inflation for July at 1230 GMT. Both the underlying and headline monthly increases are expected to be 0.2 percent, according to a Reuters poll of economists.