* Dollar hits 3-month high vs basket of currencies
* Yen rebounds vs dollar, euro; month-end flow supports
* European stocks lurch lower; banking sector weighs
* Japan industry output down 10% in January
By Veronica Brown
LONDON, Feb 27 (Reuters) - The dollar rallied sharply on Friday, hitting a three-month high versus a basket of currencies, taking a lead from faltering European stock markets as banking sector worries returned to stalk investors.
Bank shares fell sharply, led by Lloyds Banking Group after a 2008 statutory loss of 10.8 billion pounds ($15.4 billion). The bank also said it was in talks to place billions of pounds of assets into a UK-government backed insurance scheme.
The yen gained sharply, snapping a string of losses that took it to three-month lows this week against the dollar, with dealers citing month-end flows even as Japanese industrial output data continued to paint a bleak picture of the economy.
"We have a reasonably straightforward link between the currencies and the vagaries of the equity markets and risk appetite," said Daragh Mayer, deputy head of FX research at Calyon in London.
"We've had some pretty weak numbers out of the United States which keeps risk aversion high and the dollar well supported," he added.
U.S. data on Thursday showed sales of newly built single-family homes slumped in January to the lowest since at least 1963. Other reports showed U.S. durable goods orders fell for a sixth consecutive month to a six-year low in January.
By 1036 GMT, the dollar was up 0.4 percent on the day at 88.168, having earlier hit a three month high of 88.328.
The euro fell half a percent to $1.2667, while yen strength pulled the single currency down 1.4 percent to 123.45 yen.
Elsewhere, the Swedish crown tumbled to a record low against the euro after data showed the Swedish economy contracted more than twice as much as forecast in the fourth quarter.
YEN OFF LOWS
Sentiment towards the euro was also undermined by stock market losses as investors shrugged off news that global development banks had launched a coordinated plan to lend up to 25 billion euros to shore up banks in crisis-hit eastern Europe.
"It is a step in the right direction, but the amount is small. Concerns about the adverse effect of Eastern European economies on Western Europe banks continue to weigh on the euro," said Adarsh Sinha, currency strategist at Barclays Capital.
The dollar lost 0.9 percent to 97.48 yen -- taking it further away from three month highs hit the previous day at 98.70 according to Reuters data.
On a monthly basis the dollar is on course for a rise of nearly 9 percent on the yen, its biggest monthly gain in percentage terms since 1995.
But Japanese data continued to paint a gloomy picture of the economy, dampening prospects of a sustained yen rebound.
Japanese industrial production plunged 10.0 percent in January from the previous month, posting its biggest drop on record and underscoring the sombre outlook that has helped drive the yen lower in the past couple of weeks.
Dealers said the data did little to change views that the yen would resume its slide once profit-taking and month-end selling by Japanese exporters, to benefit from the favourable exchange rates, had worked its way through.
The yen has fallen nearly 11 percent against the dollar since hitting a 13-year high of 87.10 yen in January, with the slide steepening after poor GDP numbers last week and the resignation of the finance minister after he was forced to deny being drunk at a G7 meeting.
(Additional reporting by Tamawa Desai in London; Reporting by Veronica Brown and Farah Master; Editing by Ruth Pitchford)