(Updates 0352 GMT)

By Ankur Banerjee

SINGAPORE, July 12 (Reuters) - The yen was soft after a

volatile start on Friday as traders weighed its sharp surge

after U.S. consumer prices unexpectedly dropped, stoking

speculation that Tokyo had intervened to lift the currency away

from 38-year lows.

The Japanese currency swung between gains and

losses in early trading before trading slightly weaker. It was

last down 0.27% at 159.27 per dollar.

It spiked nearly 3% to as high as 157.40 immediately after

the consumer inflation report on Thursday.

Tokyo's top currency diplomat, Masato Kanda, said on

Friday authorities will take action as needed in the foreign

exchange market but declined to comment on whether authorities

had intervened.

"Currency interventions should certainty be rare in a

floating rate market, but we'll need to respond appropriately to

excessive volatility or disorderly moves," Kanda said.

The usual absence of any official comment on intervention

leaves investors guessing and focus will now be on data due at

the end of the month that shows whether authorities did step in

or not.

News outlet Asahi, citing government sources, said officials

intervened in the currency market while a Nikkei report, also

citing sources, said the BOJ conducted rate checks with banks on

the euro against the yen on Friday, adding to market jitters.

"It's just being opportunistic ... (and) the U.S. data

is doing the heavy lifting," said Moh Siong Sim, currency

strategist at Bank of Singapore. "If they did intervene it shows

their intention to cap yen weakness."

Tokyo intervened at the end of April and in early May,

spending roughly 9.8 trillion yen ($61.55 billion) to support

the currency.

However, the yen has since gone beyond those levels,

touching a 38-year low of 161.96 per dollar last week as the

wide difference between U.S. and Japan rates weighed, with the

currency down over 11% against the dollar so far this year.

This gap has created a highly lucrative trading opportunity,

in which traders borrow the yen at low rates to invest in

dollar-priced assets for a higher return, known as carry trade.

"It looks like it will be a volatile day today with

markets nervous about intervention but carry still very

attractive to short the yen and the shift in the fundamental

story is only marginal after last night's cooler U.S. CPI," said

Charu Chanana, head of currency strategy at Saxo.

CPI BOOST

The surge in yen was triggered after data on Thursday showed

U.S. consumer prices fell for the first time in four years in

June, firmly putting disinflation back on track and keeping an

interest rate cut from the Federal Reserve on the table.

"The U.S. inflation report was about as good as any dove

could have hoped for," said Matt Simpson, senior market analyst

at City Index, pointing out that recent data more than suggest

the U.S. economy is slowing.

Traders are now pricing in 93% chance of the Fed cutting

rates in September, compared with 73% before the CPI reading,

CME FedWatch tool showed. Markets are pricing in 61 basis points

of easing this year.

The dollar as a result has been on the defensive, with

the dollar index, which measures the U.S. currency

against six rivals, at 104.49, not far from the one-month low of

104.07 it touched on Thursday.

"With the likelihood of a dovish September Fed rate cut,

we could see a softer dollar in the near term," said managing

director of investment strategy at OCBC.

Menon, though, cautioned that the market is pricing in a

more aggressive pace of rate cuts and flagged the risk of a

Donald Trump victory in the upcoming U.S. Presidential election.

"A resurgence of inflation expectation if Trump wins

could see the Fed treading cautiously next year."

Elsewhere, the euro was steady at $1.087, just

below the one month high of $1.090 touched on Thursday.

Sterling was hovering close to the nearly one-year

high hit on Thursday and was last at $1.29075 after data showed

the UK economy grew more quickly than expected in May,

potentially lowering the chances of an August rate cut.

($1 = 159.2200 yen)