FOREX-Dollar, yen gain upper hand as stocks tumble

* Dollar, yen rise as equity markets turn sharply lower

* Yen surges on yen cross unwinding; euro/yen down 2.2 pct

* Dollar index up 0.8 percent at 85.442 <.DXY>

* Euro extends loss after euro zone Q4 GDP revised down

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By Tamawa Desai

LONDON, April 7 (Reuters) - The dollar and yen rose on Tuesday as equity markets took a sharp turn lower, fuelled by concerns about the banking sector that wiped out recent optimism over the global economy.

The yen rebounded broadly and sharply, as short-term market players unwound yen crosses, traders said. The dollar was broadly higher except against the yen.

European shares were down one percent after opening modestly higher on Tuesday, as financials weakened along with U.S. stock futures, also down more than one percent.

The DJ Stoxx Banks Index <.SX7P> dropped 3.1 percent after U.S. stocks fell on Monday as a prominent analyst revived worries over the health of banks. [ID:nN06322858]

Markets were also jittery ahead of earnings season in the United States.

"Correlations with the U.S. equity market have been stronger over the last month for most currencies than with overall risk appetite," said Daragh Maher, deputy head of global FX strategy at Calyon.

"It also shows that short-term forex forecasting has largely become a game of second-guessing equity markets."

By 1108 GMT, the euro was down 2.2 percent against the yen at 132.32 yen while the pound was down 1.8 percent versus the Japanese currency . The New Zealand dollar was down 2.8 percent against the yen .

The dollar was down 0.9 percent at 100.04 yen after dipping to 99.88 yen, but the greenback gained broadly elsewhere. Against a basket of currencies, the dollar rose 0.8 percent to 85.442 <.DXY>.

WORSE GROWTH

The euro fell 1.2 percent at $1.3240 after hitting a session low of $1.3232 as selling accelerated after data showed a record contraction in the euro zone economy.

Figures showed euro zone gross domestic product fell by 1.6 percent in the fourth quarter, the deepest ever quarterly fall and more than the 1.5 percent decline reported previously. Economists polled by Reuters had not expected a revision. [ID:nL798677].

"Heightened financial sector problems clearly increasingly impacted through the fourth quarter, adding to the euro zone's already significant problems," said Howard Archer, chief European economist at IHS Global Insight.

U.S. bank shares slipped on Monday after veteran analyst Mike Mayo of Calyon Securities warned of rising loan losses by the end of 2010. He rated a number of big and regional banks at "underperform" or "sell."

An unsourced report in The Times newspaper also said the International Monetary Fund was set to warn that toxic debt racked up by banks and insurers could hit $4 trillion. [ID:nT186243].

On sterling, investors took little comfort from UK data showing British manufacturing output fell by less than expected in February, with a 0.9 percent monthly drop still marking the 12th straight month of declines [ID:nONS004158].

Meanwhile, the Australian dollar fell 0.8 percent against its U.S. counterpart to $0.7069 after choppy trade in the wake of the Australian central bank's 25 basis point rate cut to a record low 3.0 percent. It said it saw scope for only modest easing further out. [ID:nSYD452265]. (Additional reporting by Jessica Mortimer; editing by Patrick Graham)