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* Asian currencies sharply reverse weeks of gains
* South Korea won at 3-mth low on stock investment outflows
* Taiwan dlr hits 4-mth low on foreign financial outflows
By Jongwoo Cheon
SINGAPORE, Jan 28 (Reuters) - Foreign portfolio outflows from South Korea triggered a round of heavy selling in Asian currencies on Monday, driving the largest daily fall in the won in 16 months and raising the spectre of sustained volatility in the region's currency market.
The won fell 1.7 percent against the dollar, its largest daily percentage fall since Sept. 26, 2011. The Taiwan dollar slipped to its weakest in more than four months.
Foreign investors reported their largest daily stock sales in 16 months on Korea's KOSPI index.
Currency analysts said the sharp decline in the Asian currencies appeared to be driven by a combination of factors: profit-taking by foreign portfolio investors, the euro's rally on Friday and some concern that the regional units had risen too far against a weakening yen.
While those factors do not detract from the fundamental attractiveness of Asia's growth and high-yielding markets, the risk was that foreign capital outflows would lead to contagious currency depreciation, helped by regional authorities concerned about the erosion of competitiveness versus the yen, they said.
"There could be some further pullback in Asian FX. A higher dollar/yen will drag the rest with it and Asian central banks will be happy to see some local currency weakness," said a senior U.S. bank trader in Singapore.
Until recently, Asian currencies were major targets of investors looking for higher yields with cheap money printed by major central banks, especially the Bank of Japan (BoJ).
Last week, the BoJ announced its most radical effort yet to end years of economic stagnation, after weeks of relentless pressure from new Prime Minister Shinzo Abe for a greater push to lift the economy out of recession.
That push for aggressive monetary easing has pushed the yen down. On Monday, the dollar climbed as far as 91.25 yen, its highest level since June 2010.
Asian currencies have been climbing against the yen, giving policymakers in Korea and China much angst over a loss of competitiveness. The won fell below the 12-per-yen level this month, a level deemed highly sensitive for Korean electronics exporters, before South Korean authorities stepped up rhetoric.
On Saturday, Bank of Korea Governor Kim Choong-soo said Japan's monetary easing had "created problems".
Last week, China's foreign exchange regulator warned of speculative capital inflows.
"The currency war story is starting to grab some attention and people are buying dollars ahead in anticipation of weakening of Asian currencies to catch up with the yen," said a European bank dealer in Manila.
HOT MONEY OUTFLOW
The won had risen 12.4 percent against the dollar between late May and mid-January. It has been slipping since mid-January, losing 3.6 percent. Monday's close of 1,093.5 to the dollar was the weakest since Oct. 30 last year.
Implied volatility on the won, priced into one-month options, jumped on Monday, rising 3 percentage points to above 9 percent.
That would be a warning sign for the region's central banks, most of which have stated that they are apprehensive of big swings in their currencies, not about fundamental weakness or strength.
"To me what the authorities get angry about is very rapid moves, as we have seen recently," said Jonathan Cavenagh, strategist at Westpac Banking Corporation.
"Once the dust settles, I think most countries around this region won't be afraid of currency strength but would prefer it in a gradual manner."
Yet some currency traders were preparing for the won's slide to accelerate repatriation from the country's stocks.
"We'd better prepare for a level of 1,100 soon," said a senior foreign bank dealer in Seoul.
The Indonesian rupiah slid more than half a percent and was traded at levels around 9,790-9,800, although the central bank was spotted providing dollars to the market, traders said.
Westpac's Cavenagh said it seemed like Monday's move was merely a market shedding some heavy bullish positions in Asian currencies, rather than any shift towards being short in the Asians. (Writing by Vidya Ranganathan; Additional reporting by Miao-jung Lin in TAIPEI and IFR Markets' Catherine Tan; Editing by Richard Borsuk and Robert Birsel)