* Yen takes hit as optimism about global economy grows
* Data from China, South Korea supports risk appetite
* Investors wary about U.S. bank stress test results
By Anirban Nag
SYDNEY, May 1 (Reuters) - The yen fell to two-week lows against the U.S. dollar and the euro on Friday as investors grew confident that the pace of global economic decline was abating, boosting appetite for riskier assets.
Trading was thin, with much of Asia outside Japan, out for the May Day holiday. The yen was also hurt by data which showed Japan reporting a drop in core consumer prices, putting the country in its second round of deflation in less than two years, while the jobless rate hit a 4-year high..
Still, data from other regional powerhouses seemed to support the view that the worst for the global economy might be over. Chinese manufacturing gained momentum last month while South Korean exports fell by less than expected..
That optimism supported stock markets with Tokyo's Nikkei trading in positive territory on Friday, after ending up nearly 4 percent higher a day earlier.
"This confidence is spreading in the equity markets and risk appetite is growing more and more. As a result the yen is being sold broadly," said Toru Umemoto, chief FX strategist Japan at Barclays Capital in Tokyo. "Investors are seeking a growth gap and a rate gap and as a result the yen is a funding currency."
The dollar rose as high as 99.16 yen from 98.60 in New York on Thursday, before paring gains to 98.87.
The climb came just ahead of the local Tokyo fixing at 0100 GMT, with the market slightly short of dollars in thin conditions ahead of the fix, said Mitsuru Sahara, chief manager at Bank of Tokyo-Mitsubishi UFJ.
The euro rose to 131.52 yen, its highest since April 16, before easing back to 131.25 yen.
The Aussie also headed back towards its recent peaks on the yen, rising to 71.88 yen, not far from Thursday's two-week high of 72.56 yen.
Risk appetite has been boosted by a string of better global economic data and a note of optimism from the U.S. Federal Reserve earlier this week. Encouraging U.S. employment and manufacturing data on Thursday added to a burgeoning sense of optimism.
ISM DATA AWAITED
The influential U.S. ISM report is due late in the day and is expected to mark an improvement after economic reports showed that business activity in the U.S. Midwest contracted at a much less severe rate in April.
"Investors are looking for signs of economic stability across the globe," said Jonathan Cavenagh, a currency strategist at Westpac, Sydney.
"Any signs that data is better or in line with expectations could lift risk appetite and high-yielding currencies like the Aussie and the kiwi."
The Aussie jumped 5 percent against the U.S. dollar in April, rising to a seven-month high of $0.7384 on Thursday. The greenback fell 5.2 percent on the Canadian dollar, its biggest monthly drop since September, 2007.
The euro was at $1.3270, off a two-week high of $1.3384, with gains capped by uncertainty about whether the European Central Bank will opt to follow the Federal Reserve and embrace unorthodox policy measures such as buying securities to stimulate growth.
The dollar index against a basket of currencies fell 0.2 percent to 84.620 after hitting its lowest in nearly a month on Thursday.
So far investors are concentrating on signs of green shoots in the global economy, but sentiment remains vulnerable to jitters over a flu virus breakout as Mexico began shutting down parts of its economy to slow the spread of the virus.
Even news that U.S. automaker Chrysler filed for bankruptcy on Thursday failed to have much impact on currency markets.
But, analysts said, there would be a degree of caution ahead of next week's release of the stress test results of individual U.S. banks.
"Currency investors will be wary of taking huge positions ahead of those results," said Westpac's Cavenagh.
If banks fail the stress test and need additional capital, risk appetite could take a beating and currencies like the Aussie and the New Zealand dollar could drop. (Additional reporting by Elaine Lies; Editing by Joseph Radford)