The yen weakened on Friday as hopes of a U.S. government programme to subsidize mortgages boosted world stock markets, while data showing the deepest ever economic contraction in the euro zone hit the euro. Sterling also rallied as investors squared market positions ahead of the weekend on concerns that Group of Seven finance chiefs may discuss the currency's recent weakness, even though they're keen to avoid upsetting troubled financial markets with squabbles over exchange rates. The euro fell around a cent from intraday highs to below $1.2850 after the euro zone recession data boosted pressure for the European Central Bank to cut interest rates by half a percentage point next month to a record low 1.5 percent. "The fall in euro area GDP is unprecedented," said Jurgen Michels, European economist at Citigroup in London. "To prevent an ongoing substantial undershooting of its inflation target, we expect the ECB to cut rates by 50 basis points in March, and we expect a further reduction in rates to 0.5 percent by mid-year," he said. By 1300 GMT (8 a.m. EST) the euro was down 0.2 percent on the day at $1.2837, having earlier hit a high of $1.2942. It was down almost 2 percent against the British pound at 88.45 pence and was also down against the Swiss franc and Swedish crown. The euro rose against the yen, however, up 0.75 percent to at 117.70 yen, and the dollar rose 0.9 percent to 91.67 yen, according to Reuters data. The dollar and yen, which often show an inverse correlation to investors' risk appetite, lost ground to higher-yielding currencies as global equities recovered ahead of the G7 meeting in Rome and a long weekend in the United States. European shares were up roughly 2 percent, buoyed by the latest U.S. plan which, in a major break from existing aid programs, would seek to help homeowners before they fall into arrears, sources familiar with the plan told Reuters. G7 IN FOCUS Markets welcomed the news that the Obama administration may unveil a broad plan to put a floor under the housing market. A rising wave of U.S. mortgage delinquencies has saddled the global banking system with big losses that have led banks to recoil from lending, choking economies around the world. Attention now turns to the G7 meeting in Rome. Analysts will be looking to see how much sterling's recent slide on world currency markets features in discussions. Analysts said the bleak euro zone GDP figures had also raised concerns that G7 leaders may discuss the pound's recent weakness against the euro. French Economy Minister Christine Lagarde last month called for Britain to do something about its currency as France worried that its businesses will lose out to cheaper British goods and services just when recession is spreading across the industrialized world.

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