High yielding currencies fell sharply in volatile markets on Friday as a sell-off in credit and stock markets led investors to pare risky carry trades.

The rise in risk aversion originally sent the low-yielding yen to a three-month high against the dollar and a six-week high versus the euro. But the Japanese currency's gains proved short-lived, in part due to soft retail sales data from Japan.

The S&P 500 shed about $300 billion in market value in the worst single session since February overnight. On Friday, Japan's Nikkei average dropped to a 3-month low, and the FTSEurofirst fell 1 percent in early trade, though it trimmed early losses to trade around 0.3 percent down.

The New Zealand and Australian dollars fell sharply for the second consecutive day as increasingly risk averse investors cut back carry trades where they borrow low yielding currencies like the yen to fund purchases of higher yielding assets.

Every single stock market in the world except Sweden's is down, reflecting risk aversion resulting from problems in credit markets and this is leading high yielding currencies to fall, said Naeem Wahid, currency strategist at HBOS.

The Australian dollar tumbled 1 percent versus the U.S. dollar and the New Zealand dollar fell 0.6 percent in a sharp retreat from 18 and 22 year peaks, respectively, set earlier this month.

Sterling, another high yielder, was down 0.5 percent to $2.0376 at 0822 GMT, well off the $2.0655 hit on Tuesday.

The euro was down 0.25 percent versus the dollar at $1.3708 off a $1.3853 record hit earlier in the week.

RISK AVERSION AT 6-YEAR HIGH

The UBS Risk Index which measures risk averse behavior was at its highest level since September 2001, the month of the 9/11 attacks on U.S. cities. Analysts said the current environment was leading investors to safe haven assets.

Equities are down, credit is wider, volatility is wider, swap spreads are wider so the whole picture is taking shape of the classical flight to quality move, said Jean-Francois Robin, strategist at Natixis in Paris.

The yen rose to a three-month high of 118.18 per dollar before retreating to 119.08. It set a 1-1/2 month high of 162.40 per euro before retreating to 163.16.

Japanese retail sales fell 0.4 percent in June from a year earlier government data showed on Friday, falling short of economists' median forecast for a 0.6 percent increase.

Another factor weighing on the yen was Sunday's election for half the seats in the upper house of Japan's parliament. The ruling Liberal Democratic Party is seen faring poorly due to funding scandals and voter anger over lost pension records.

Should the LDP lose by a greater-than-expected margin, prime minister (Shinzo) Abe may be forced to step down and the resulting political uncertainties could bolster expectations for the BoJ to postpone rate hikes at the August 22-23 meeting. This would be bearish for the yen, JP Morgan said in a client note.

U.S. second quarter gross domestic product growth data are due later in the session. The median forecast in a Reuters survey is for growth to rebound to 3.2 percent after braking sharply to 0.7 percent in the first quarter.

Japan Nikkei 225