* Asia stocks drop 1 pct, hold up after Wall St slide
* More profit-taking in risky assets expected before year-end
* Aussie and higher-yielding FX bounce back from early drop
* VIX spike spooks, but Nikkei implied vol rise limited
By Eric Burroughs
HONG KONG, Nov 2 (Reuters) - Asian stocks slipped to a one-month low on Monday after a sell-off in banking shares slammed Wall Street, a slide viewed as a sign that investors are losing faith in the economic recovery.
European shares were set to edge higher at the start, with futures on the Dow Jones Euro Stoxx 50 inching up 0.1 percent.
Worries about the U.S. financial sector resurfaced after CIT Group Inc, the lender to small and mid-sized U.S. companies, filed for bankruptcy and an accounting expert said Citigroup may need further write-downs.
But the fallout on Asian equity markets was limited and higher-yielding currencies quickly recovered from early losses, with some market players blaming the volatile moves on profit-taking and portfolio reshuffling before year-end.
Chinese manufacturing activity accelerated to an 18-month high in October, underscoring that Asia's engine of growth is powering ahead even as demand from the United States and other major economies remains weak.
The dollar dipped while oil prices edged higher to bounce back from a sharp drop on Friday along with shares. U.S. crude oil was up 35 cents a barrel to $77.35.
Hedge funds and other players were cited as sellers of emerging market stocks and currencies last week, looking to take profits on their best trades before many funds close their books for the year in November.
"We have seen modest redemptions out of our pool of funds and that is mainly because of a brief round of profit taking and risk reduction by clients who allocated early this year," said Adam Matthews, head of the Asian client portfolio management team at JP Morgan Asset Management in Hong Kong.
"Judging from the money parked on the sidelines by pension funds, insurers and private banks its difficult to believe the market can fall more than 10-20 percent in the short term. In the long term we don't expect the yo-yo like volatility in the region's markets to continue as institutional allocation is here to stay," said Matthews, who manages funds worth $58 billion.
The MSCI index of Asia-Pacific shares outside Japan fell 1 percent, touching a one-month low but still up nearly 60 percent this year. The Thomson Reuters index of regional stocks shed 1.5 percent.
Investors sold $530 million in shares in Asia ex-Japan last week but have snapped up $50.6 billion so far this year, with South Korean and India taking in the biggest amount of funds.
Japan's Nikkei average dropped 2.3 percent, mirroring the 2.8 percent slide in the U.S. S&P 500 on Friday -- its biggest one-day drop since July. But futures on the S&P edged up in Asia, providing some relief that the selling pressure would not extend into the new month.
VOLATILIY IS BACK
A spike in the VIX volatility index on the S&P, known as Wall Street's fear gauge, also stirred worries that investors were starting to brace for a deeper drop in stocks.
But the move in the equity options market was not mirrored in Asia. Implied volatility, a gauge of option market expectations of future moves, on Nikkei futures edged up only slightly.
The slide in U.S. shares came despite an array of positive third-quarter earnings.
Thomson Reuters data shows that 80 percent of the 344 companies in the S&P 500 that reported earnings so far have beat expectations.
Gains in higher-yielding currencies weighed on the dollar. Its gauge of its performance against six major currencies dipped 0.2 percent to 76.250.
The Australian dollar rose 0.7 percent to $0.9044, while the euro edged up 0.2 percent to $1.4745.
Some of the early volatility in higher-yielding currencies was due to a sharp fall in the South African rand tied to selling by a Japanese margin trader broker. Traders suspected that a mistaken trade may have sparked the sharp drop.
Government bonds gained on the stock market woes. The benchmark 10-year Japanese government bond yield dipped 3 basis points to 1.375 percent, down from a 2-½ month high reached last week. (Additional reporting by Parvathy Ullatil; Editing by Neil Fullick)