S.Africa's rand up 3 pct vs. dollar, bonds follow

South Africa's rand firmed over three percent on the dollar on Tuesday and was the biggest gainer in a basket of emerging market currencies watched by Reuters, as investors returned to riskier assets on hopes Europe's debt crisis will be solved.

The rand surged on the day as the market also saw last week's heavy losses as overdone, while bonds rallied in line with better global sentiment.

The rand has lost 22 percent so far this month, falling to its worst level in over two years on Thursday.

However, it has been on a major bounce in the last three sessions, recovering 8 percent since hitting a 28-month low of 8.4950 on Thursday. By 1530 GMT it was trading 2.86 percent firmer against the dollar at 7.80, after earlier hitting 7.7813. It closed at 8.03 in New York on Monday.

Global markets are encouraged by hopes that European policymakers will ease the region's debt crisis.

Its part of a pull back after last week's blowout, most things are stabilising. There is a little bit of risk back-on after those shenanigans: last week's move on the rand was very much an overshoot, so everything is coming back into line, said Jim Bryson, a trader at Rand Merchant Bank.

Sentiment is likely to remain fragile though until investors see decisive action to curb European debt, and with some traders waiting it out, volume is at it lowest in three days and moves are somewhat exaggerated.

We've seen in the last few weeks that any kind of stability tends to be fleeting and therefore we're going to take this all with a pinch of salt, Bryson said.

He said 7.80 was the next key level for the currency, after breaking through the psychological 8 rand level in two sessions.

Government bonds followed the firmer trend, taking advantage of the risk-on trade to attract some foreigners back into the market. The 2015 yield closed 18 basis points lower at 6.88 percent. The yield on the 2026 note fell 14 basis points on the day to 8.44 percent.

Demand for risk globally which began in U.S equity markets overnight filtered through. That's seen the rand and bonds rally quite significantly and it looks like with the currency going below 7.80 now ... I suspect we'll see more bond strength come tomorrow morning, said Richard Farber, bond trader at World Wide Capital Securities.