(Updates numbers after European morning)

* Yen rallies on prospect Japanese pension funds will invest

more domestically

* Markets largely unfazed by renewed Middle East tensions

for now

* U.S. dollar falls; New Zealand dollar gets rates boost

By Rae Wee

LONDON/SINGAPORE, July 10 (Reuters) - The yen bounced on

Friday on news that Japan plans to encourage pension funds to

increase their holdings of domestic financial assets, a move

analysts said could offer more support to the battered currency

than intervention.

Japanese Finance Minister Satsuki Katayama said the government

was pursuing measures that would include encouraging the

Government Pension Investment Fund, one of the largest pension

funds in the world, to make "substantially greater investments

in Japanese financial assets".

The yen jumped from the weaker side of 162 per dollar to

an intraday peak of 161.285. It was last 0.38% stronger at

161.75 per dollar.

"The pension funds are pretty large in size (and) currently,

50% is allocated to foreign investments in their strategic

allocation, (so) a shift in that would definitely create a lot

more inflows for domestic assets," said Fabien Yip, a market

analyst at IG.

"That's supportive of the currency and at the same time,

also supportive of equities and bonds."

BROAD-BASED YEN RALLY

The rally was broad-based, with the euro and British

pound down around 0.3% and 0.2% respectively against

the yen.

Before Friday's news, the yen had been languishing near 40-year

lows, keeping traders on guard for potential intervention by

Japanese authorities.

The yen's rise on Friday in turn pushed the dollar lower, as it

fell a touch against a basket of currencies to 100.85.

The world's most traded currency was set to end the week little

changed.

The euro was steady at $1.1430, while sterling was

0.16% higher at $1.3424.

WAR CLOUDS SENTIMENT

Investors for now seemed to brush off flaring tensions in the

Middle East, but the implosion of a ceasefire between the U.S.

and Iran has once again cast a cloud over the outlook for energy

prices and global inflation.

"The spectre of war still hangs over sentiment," said

Thierry Wizman, global FX and rates strategist at Macquarie

Group.

"The question confronting traders is whether Iran is willing

to return to large-scale kinetic war with the U.S. and its

allies if necessary to strengthen its claim of control over the

Strait of Hormuz."