(Recasts, updates prices, adds quotes and comment, changes byline)
By Jamie McGeever
LONDON, Oct 16 (Reuters) - The yen strengthened sharply on Tuesday and high-yielding currencies like the New Zealand dollar fell as a sell-off in equity markets prompted currency traders to unwind their yield-seeking carry trades.
Booming oil prices to new highs, a near 30 percent plunge in telecommunications giant Ericsson's shares (ERICb.ST: Quote, Profile, Research) and worries over more bleak earnings from financial institutions this week increased investors' sense of risk aversion.
Ahead of the weekend meeting between Group of Seven finance ministers and central bankers, at which exchange rates could be discussed, traders decided to book profits on Tuesday.
"It's a mixture of risk aversion being triggered by the news from financial institutions that not only were things bad in Q3 but could be bad in Q4 ... and also some risk being taken off the table ahead of G7," said Derek Halpenny, senior currency economist at BTM-UFJ.
Reduced risk appetite prompts investors to scale back carry trade investments where cheap borrowing in the low yielders like the yen funds purchases of higher return currencies such as the New Zealand dollar.
At 1115 GMT the euro was down one percent on the day at 165.12 yen <EURJPY=>, falling back from the 2-1/2 month peaks of 167.72 yen the previous day.
The dollar was down 0.6 percent at 116.64 yen <JPY=>, retreating from Monday's two-month high of 117.94 yen, while the New Zealand dollar, a carry trade favourite, fell 2.7 percent to 86.08 yen <NZJPY=R>
The euro fell 0.4 percent to $1.4155 <EUR=> and sterling, weighed by below-consensus UK inflation data, fell 0.6 percent to $2.0310 <GBP=>.
OIL, GOLD SURGE
The rise in risk aversion helped ensure Japan's Nikkei stock market closed 1.3 percent lower (.N225: Quote, Profile, Research) and the FTSEurofirst 300 index of European shares was last down almost 1 percent (.FTEU3: Quote, Profile, Research), tracking the weakness in Asian and U.S. equities overnight sparked by a gloomy outlook from Citigroup.
Investors are monitoring reports from the financial sector carefully for clues on how deeply it has been affected by troubles in the U.S. subprime mortgage sector and the subsequent credit crunch. JP Morgan and Bank of America are among those reporting their third quarter results this week.
But while the yen's gains and carry unwind Tuesday have been impressive, traders are mindful that even sharper moves a couple of months ago were short-lived and subsequently led to several weeks of broad yen weakness.
Once banks' earnings and the G7 meeting are out of the way, investors' appetite for carry could return.
"Look back at the summer correction and look how well we have come back. It seems the only way now - buy the dip for long carry," said a London-based trader at a Japanese bank.
Euro zone economic data on Tuesday, meanwhile, failed to move currencies or interest rate expectations much.
The ZEW October index of German investor sentiment was slightly stronger than forecast while the final estimate for euro zone September inflation rose as expected. For more, click on links [nL16279549] and [nL16263153].
The European Central Bank has retained a hawkish tone lately in contrast to the Federal Reserve, which slashed rates by 50 basis points to 4.75 percent last month and is widely expected to loosen policy again by year-end.
Reflecting the rise in inflation expectations in some quarters, gold on Tuesday hit a fresh 28-year peak to come closer to the $800-an-ounce barrier <XAU=> and oil jumped to new peaks, bringing $90 a barrel and even $100 into view (CLc1: Quote, Profile, Research).
Traders showed limited reaction to a speech by Fed Chairman Ben Bernanke, who said late on Monday that U.S. financial markets are healthier after a turbulent summer, and that the Fed would support market stability and non-inflationary growth.
U.S. data on tap later Tuesday include Treasury investment flows data for August at 1300 GMT and September industrial output at 1315 GMT.