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By Veronica Brown
LONDON, Aug 16 (Reuters) - The yen soared to five-month highs against the dollar and euro while the high-yielding Aussie and Kiwi dollars tumbled on Thursday as spreading credit market problems again prompted investors to unwind carry trades.
The New Zealand dollar was the hardest hit, plunging about 4.5 percent against the yen at one point as market players scrambled to buy back the low-yielding yen they had sold over recent weeks and months to buy higher-yielding currencies.
European stocks fell sharply, mirroring falls in Asian and U.S. shares which took a battering after stocks in Countrywide Financial, the largest U.S. mortgage lender, plunged on a brokerage downgrade and rumours it was having trouble raising money.
Markets are on tenterhooks for any fresh evidence that problems in the subprime credit market are spreading to the wider economy, leading investors to pile into safer, lower yielding currencies.
"It's very clear that financial market gyrations continue to exert the most dominant theme on FX markets, highlighted by Aussie lower, kiwi lower," Bank of America currency strategist Kamal Sharma said.
"There's a perception from the investor community that this (carry unwind) is a little bit more entrenched than the last bout of significant carry unwind in February. This is a broad based concern about the state of the global financial system," he added.
By 1000 GMT, the dollar was down 0.6 percent to 115.74 yen, having fallen to 115.57 <JPY=>, its lowest since March.
Reflecting the fears of the markets remaining rocky, the implied volatility on one-month dollar/yen options (JPYVOL: Quote, Profile, Research) -- how much a currency pair is seen moving over a given period -- soared above 14 percent to its highest in over seven years.
The New Zealand dollar -- whose 8.25 percent yield has made it one of the most popular currencies for carry trades -- was down 3.4 percent versus the U.S. dollar at $0.6820 and 4.06 percent against the yen at 78.99 yen <NZDJPY=>.
The euro slid as much as 1 percent to a five-month low of 155.00 yen before edging back to 155.59 yen <EURJPY=>.
The single currency was steady against the dollar at $1.3422 <EUR=>, after hitting a two-month low of $1.3387 according to Reuters data.
U.S. Treasury Secretary Henry Paulson told the Wall Street Journal that while the market volatility would hurt U.S. growth, the economy and financial system was strong enough to withstand losses without provoking a recession. [ID:nTKW002844]
And St. Louis Federal Reserve Bank President William Poole said on Wednesday there was no need for an emergency rate cut. [nL1694744].
Japanese Prime Minister Shinzo Abe said on Thursday the nation's economy remains in good shape and he expects the Bank of Japan to make an appropriate decision on monetary policy while examining economic conditions.
The widening array of credit market losses has rattled investors, even hitting the confidence of banks lending to each other, prompting hefty injections of cash by central banks in the past week to relieve a money market squeeze.
"The effects from U.S. credit on global markets remains consistent with a textbook case unravelling of financial contagion over a week after central banks intervened to normalise conditions," Tullett Prebon G7 economist Lena Komileva said in a note to clients.
In the middle of the carry unwind, the U.S. dollar continued to benefit broadly from a flight to the liquidity of U.S. securities.
The dollar index (.DXY: Quote, Profile, Research), which tracks the greenback against a basket of major currencies, rose for a fourth straight day to a peak of 82.13, the highest since late June.