By Jessica Mortimer LONDON, Oct 22 (Reuters) - The dollar rose sharply on Wednesday, hitting two-year highs against the euro and a basket of currencies, while the yen continued its relentless ascent as investors liquidated riskier assets. Signs that money markets were finally easing did little to improve shattered confidence as fears of a looming and protracted global recession kept investors in deleveraging mode, with European share prices tumbling over 4 percent. The translation of deleveraging into FX markets sent the low-yielding yen up broadly as carry trades were unwound, helping it hit a 4 1/2-year high against the euro. "Yen and dollar are king as safe havens and central bank proactivity rule," Bank of New York Mellon currency analyst Neil Mellor said. By 1218 GMT, the euro was down 1.6 percent on the day at $1.2842. It earlier fell as low as $1.2740 according to electronic data system EBS, its lowest since November 2006. Against a basket of six major currencies, the dollar was up 1.37 percent at 85.577 .DXY, having earlier hit a 2-year high at 85.921. Against the yen, however, the U.S. currency fell 1.4 percent to 98.88 yen. The euro tumbled 3.1 percent to 126.85 yen, having earlier hit a four-and-a-half year low of 126.30. STERLING STRUGGLE Sterling slid to its weakest level against the dollar in five years at $1.6203 , pummelled after Bank of England Governor Mervyn King said on Tuesday that Britain's economy was probably entering its first recession in 16 years. [ID:nLAG003088]. On Wednesday, King said in an interview that the Bank of England can counter the impact of the financial crisis on the UK economy by changing interest rates. See [ID:nLAC003004]. The pound was last trading down 2.3 percent against the dollar at $1.6301, on track for its biggest weekly percentage drop since Britain's exit from the European Exchange Rate Mechanism in late 1992. FRESH DOLLAR GAINS Some analysts said the dollar and the yen were well-placed for further gains, with volatility running at high levels. One-month implied volatility for dollar/yen stood at 21.5 percent . "It's still a very, very volatile environment, but it's clear the dollar and the yen will go higher," Bank of New York Mellon's Mellor said. Standard Bank G10 currency strategist Steve Barrow said in a note to clients that markets were witnessing a massive unwinding of the speculative asset bubble that has developed in recent years. "History shows that, when bubbles burst, no amount of glue, from slumping libor rates or anywhere else, can stick them back together again. The law of 'what goes up must come down' has to work its way through and, right now, it is working its way through the currency market with a vengeance," Barrow said. On that basis, Barrow said the euro could push towards $1.20 over the coming six months. (Reporting by Jessica Mortimer; Editing by Toby Chopra)

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