* Yen selling eases a bit, but more downside seen * Risk reversals favour yen calls for first time since Nov * Euro eyes Italian & Spanish govt bond auctions * Sterling hit by woeful UK manufacturing data * U.S. retail sales in focus By Ian Chua and Hideyuki Sano SYDNEY/TOKYO, March 13 (Reuters) - The yen bounced back from a 3-1/2-year low versus the dollar on Wednesday as bears took profits after its hefty fall even though the currency still looks vulnerable to expectations of radical policy easing from the Bank of Japan. But in one sign relentless selling pressure on the yen since last November may be easing, risk reversal spreads, which gauges relative demand for put and call options, flipped towards yen calls. The dollar fell 0.3 percent to 95.76 yen, yielding to profit-taking after having scaled a 3-1/2-year peak of 96.71 yen on Tuesday, where it had brought its year-to-date gains to more than 10 percent. "There's no change in the big downtrend in the yen. In the near term, the dollar/yen may fall further on profit-taking but I would say 94.50 is as low as it can go at most," said a trader at a European bank. The Japanese parliament is expected later this week to sign off on the nomination of a dovish former currency diplomat Haruhiko Kuroda as the BOJ's next governor. Kuroda has vowed to pursue radical easing in order to lift Japan's inflation rate to two percent -- something that has not happened for the better of the past 20 years. "JPY should continue to remain under pressure on growing expectations of aggressive and potentially earlier easing coming through from the BOJ," said Kiran Kowshik, strategist at BNP Paribas. But one talking point among yen traders was a drastic move in the options market, where the price of yen puts, bets that the yen will weaken, suddenly fell relative to yen calls, bets that the currency will gain. The one-year risk reversal spread fell to 0.3 percent in favour of yen calls, favouring yen calls for the first time since the yen's donwtrend began in mid-November. The move sparked speculation some long-term bets on yen weakness might have been unwound. NO RUSH TO END QE Similar to the yen, sterling rebounded on profit-taking and stop-losses after it hit a 33-month low on Tuesday after data showed British manufacturing output fell in January at the fastest pace since June, reinforcing fears the economy has tipped into its third recession since the 2008 financial crisis. The British pound fetched $1.4937, up 0.25 percent from late U.S. levels but still not far from Tuesday's low of $1.4832. "Chancellor of the Exchequer George Osborne will present his budget next week and reports have emerged that the BOE's remit could be changed to allow additional QE despite high-running inflation," said Christopher Vecchio, analyst at DailyFX. "Should this occur, the next leg lower in Gilt yields could be around the corner, which could put further downside pressure on sterling. We still find that GBP/USD should fall to $1.4200 by early-Q3." Meanwhile, the euro stood at $1.3030, well within the $1.2955-3135 range seen so far this month. Traders said the market was waiting for the outcome of government bond sales in Italy and Spain due this week for fresh cues. Italy will offer three-year and 15-year bonds at an auction later on Wednesday, while Spain plans to sell bonds due 2029, 2040 and 2041 at a special, off-calendar auction on Thursday. Traders said any signs of funding stress in the euro zone's third and fourth largest economies will no doubt weigh on the common currency. A steady euro and the yen's pullback kept the dollar index off its seven-month high hit last week following strong U.S. payrolls data. The dollar index stood at 82.49, down 0.1 percent on the day and below Friday's peak of 82.924, with immediate focus on U.S. retail sales data due at 1230 GMT. While a strong reading could fuel speculation that the U.S. Federal Reserve may wind up its stimulus, some traders also say the market's expectations of an end in the Fed's quantitative easing might be premature. "It is not like the Fed will exit from the QE at its next policy meeting. It's true the Fed board members are debating it but a lot of voting members on the Fed's policy board are dovish," said Katsunori Kitakura, associate general manager of market making at Sumitomo Mitsui Trust Bank.

Source