(Recasts, updates prices, adds quote)
By Rachel Breitman
NEW YORK, Aug 15 (Reuters) - The yen climbed to 4-1/2-month highs against the euro, and the dollar rose on Wednesday as investors, weary of worsening credit sector problems, abandoned higher-yielding currencies and risky assets like equities.
The Japanese yen soared against the Australian and New Zealand dollars as investors pared back carry trades, in which low-yielding yen are borrowed to invest in higher-yielding assets.
"Renewed concerns about the credit markets triggered ... unwinding of positions with the dollar and the yen posting further gains against most currencies," said strategists at Brown Brothers Harriman in a note to clients.
Mirroring stock market volatility, the dollar fell early against the yen, then recovered, only to decline again in late afternoon trading as the S&P 500 index turned negative on the year.
"The yen and U.S. dollar crosses have been trading tick-for-tick with the stock market right now," added Jay Bryson, global economist with Wachovia Corp. in Charlotte, North Carolina. Stock prices have become a gauge of investor penchant for risk among currency dealers, who have been buying the yen as equities decline.
The dollar was down 0.7 percent at 116.75 yen <JPY=> near intraday lows of 116.62, according to Reuters data. The euro traded 1.28 percent lower at 157.07 yen <EURJPY=>.
The New Zealand dollar <NZDJPY=> tumbled 2.34 percent to 83.07 yen while the Australian dollar <AUDJPY=> dove 2.22 percent to 95.87 yen.
But the yen was by no means the day's only winner. As carry trades continued to be unwound, and anxieties over credit problems spread to Europe and Canada, the U.S. dollar became something of a safe haven and rose against most major currencies.
The U.S. dollar index, (.DXY: Quote, Profile, Research) which tracks the greenback against a basket of the world's major currencies, rose for a third straight day, its best three days since early January, to 81.863.
The dollar rose 0.65 percent to 1.2185 Swiss francs (CHF: Quote, Profile, Research).
Getting a boost from the yen crosses, greenback rose 2.12 percent against the New Zealand dollar (NZD: Quote, Profile, Research), and 1.6 percent against the Australian dollar <AUD=>.
The euro fell by 0.64 percent against the dollar at $1.3448, sliding for a third straight day in its worst decline in six months. Investors fretted about European exposure to the U.S. subprime mortgage sector, prompting speculation that the European Central Bank would not lift interest rates next month as previously expected.
"We are in the middle of a credit market crisis in the U.S., and the truth is that European banks have a lot of exposure to this very same market," said Michael Woolfolk, senior currency strategist at The Bank of New York Mellon.
Credit and housing sector problems continued to make headlines, weighing on both U.S. and European equities markets, and fueling safe-haven currency trades. Sterling, already reeling from tame UK inflation data on Tuesday, fell below $1.99 to a low of $1.9857 before modestly recouping losses to trade at $1.9912, down 0.3 percent.
"There is still a lot of uncertainty regarding the real damage that may be caused by the subprime market," said Woolfolk. "The euro and also the sterling could keep getting pounded."
U.S. government reports earlier on Wednesday showed increases in July industrial output and core consumer inflation, which excludes food and energy prices, in line with expectations.