(Updates price, adds quotes, changes byline)
By Toni Vorobyova
LONDON, Aug 29 (Reuters) - The yen weakened on Wednesday as investors, calmed by stabilising stock markets, locked in profits from a risk-aversion fuelled rally in the Japanese currency.
Soft data from the U.S. housing and consumers sectors and news of more financial institutions being affected by troubles in the U.S. subprime mortgage sector led to a broad sell off in risky assets earlier in the week.
In foreign exchange, the resulting unwinding of yen-funded carry trades helped the Japanese currency add around 2 percent this week against the euro, sterling and the dollar.
But with European equity markets stabilising on Wednesday and U.S. stock futures pointing to a higher open on Wall Street, investors banked profits from the yen rally.
"Risk aversion was driving the markets yesterday and overnight and now there is a little bit of profit taking," said Niels From, currency strategist at Dresdner Kleinwort.
"But of course it is still an environment where risk perception is the main market driver and if we get any news out of the financial industry about losses, that will hit the market instantaneous. But until then we are in a wait-and-see mode."
U.S. weekly mortgage applications data at 1100 GMT could be the next indication of the extent to which subprime troubles are spilling out into the wider economy.
By 0930 GMT the dollar was up 0.6 percent at 114.80 yen <JPY=>, rebounding from an earlier one-week low of 113.88.
The dollar was helped in part by buying by Japanese importers looking to complete their hedging needs before the end of the month, traders said.
The euro added half a percent to 156.12 yen <EURJPY=>, while the high-yielding New Zealand dollar gained 0.5 percent <NZDJPY=R>.
Nomura Asset Management's launch of two new Japanese mutual funds investing in overseas assets was seen as a positive for other currencies against the yen. Nomura said the funds attracted about 190 billion yen ($1.7 billion) of subscriptions.
Despite the yen's sharp rally this month, Japanese investors have kept ploughing funds into investment trusts that feature foreign stocks and bonds. Such outflows have been a key factor behind the yen's broad decline in the past few years.
NEXT FED MOVE
The minutes of the Fed's August 7 meeting showed officials were worried that a policy response could be needed to deal with worsening financial markets and that it might take some time before conditions returned to normal.
Speculation is rising that the Fed might cut the benchmark fed funds rate from 5.25 percent at its next meeting in September, although the central bank maintained its focus on inflationary risks in its August minutes.
"Central bank policy interpretation will be the key for successful currency and risky asset trading. While there is little doubt the Fed will cut interest rates, the question remains if the Fed will put itself ahead or behind the curve," BNP Paribas said in a note to clients.
"Aggressive interest rate cuts would certainly leave the impression that the Fed stands ready to bail out speculative investors, but such a policy move would be in sharp contrast to what the Fed and other central banks were saying over the past year, namely that risks were mispriced leading to a misallocation of capital."
Doubts have also mounted about whether the European Central Bank will push ahead with an interest rate rise next week.