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Yen rallies, Japanese stocks drop as coalition cracks

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Red hot rally in world stocks has paused this week

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Gold at $4,000 an ounce mark, silver above $50

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China expands restrictions on sales of rare earths

(Updates throughout with European market moves)

By Marc Jones

LONDON, Oct 10 (Reuters) - Breathless bulls took a break

on Friday as record-setting stocks and gold prices dipped and

the dollar headed for its best week in over a year after a run

of falls for the yen and euro.

A day after a historic ceasefire between Israel and Hamas,

the political developments were still coming thick and fast -

and continuing to move markets.

Japan's yen was jolted out of its slide and the

Nikkei dropped 1% on news the Komeito party was quitting

its coalition with the Liberal Democratic Party (LDP).

That raised doubts over still-to-be-confirmed new Prime

Minister Sanae Takaichi, whose pledges of major fiscal stimulus

and calls for the Bank of Japan to hold off rate hikes have

sapped the yen and lifted the Nikkei 6% until Friday.

"If Takaichi doesn't become prime minister, or at least

can't govern effectively, you don't really have much of a

'Takaichi trade'," said Chris Scicluna, head of research at

Daiwa Capital Markets Europe.

European markets also saw a low key start as traders

there waited to see whether France's President Emmanuel Macron

can find a way out of his country's political crisis.

He is expected to name his sixth prime minister in under two

years later, a personality who faces the vexing mission to steer

a belt-tightening budget through a deeply fragmented parliament.

The pan-European STOXX 600 was steady at 571

points, heading for a third straight weekly gain. The CAC 40 in

Paris was up 0.3% on the day along with the euro,

although that is set for its worst week since July.

The yield gap between 10-year French government bonds and

uber-safe German Bunds - a market gauge of the

risk premium investors demand to hold French debt - was also

back at 80 bps having surged to 88 bps earlier in the week.

"At the moment the market is happy," Daiwa's Scicluna said,

referring to the prospect of the French crisis easing.

"Next year could well be another very different situation

though," he added, referring to if it all falls apart again.

"Spreads could break out to the highest levels since Mario

Draghi's 'whatever it takes' speech," he said, referring to then

ECB President Draghi's speech in 2012 aimed at ending the euro

crisis.

RARE EARTH CURBS

U.S. stock futures found a bottom in Europe, with corporate

earnings season for the third quarter due to kick off on Wall

Street next week.

S&P 500 e-minis were up 0.1%, while the U.S. dollar

index, which measures the greenback's strength

against a basket of six currencies, was on course for a 1.6%

weekly rise, its best since November, despite a 0.2% dip on the

day.

Chinese stocks had tumbled 1.4% overnight

meanwhile, after Beijing expanded its rare earths export

controls on Thursday, tightening control over the sector ahead

of talks between Presidents Donald Trump and Xi Jinping.

Beijing also ramped up enforcement of its chip import

restrictions, aiming to reduce domestic technology companies'

dependence on U.S. products such as Nvidia's artificial

intelligence processors, the Financial Times reported on

Friday. Reuters could not immediately verify the report.

With the U.S. government still in shutdown mode, the yield

on the benchmark 10-year Treasury bond fell to 4.12%

compared with its U.S. close of 4.14%.

Traders expect the Federal Reserve will cut U.S. interest

rates again on October 29, with Fed funds futures pricing a

94.6% probability of a 25-basis-point rate cut, according to the

CME Group's FedWatch tool.

ALL THAT GLITTERS

Gold edged back up to $4,000-an-ounce in Europe,

having seen a brief bout of selling after topping the threshold

for the first time ever this week.

Silver which has risen even more than gold this year

was also back above the $50 mark that it breached for the first

time on Thursday.

Multiple factors aided the rally, including geopolitical

risks, robust central bank buying, exchange-traded fund inflows,

expectations of U.S. rate cuts, and trade-related uncertainties.

In energy markets, Brent crude slid 0.7% to $64.72

per barrel, after Israel's government ratified a ceasefire with

the Palestinian militant group Hamas on Friday, clearing the way

to suspend hostilities in Gaza within 24 hours and free Israeli

hostages held there in days.

(Additional reporting by Gregor Stuart Hunter in Singapore;

Editing by Susan Fenton)