FOREX-Dollar strengthens as U.S. yields spike, pound falls to one-week low

* Dollar lifted by rise in yields

* Pound falls to over one-week low

* Bitcoin slips 5%

* Graphic: World FX rates

By Ritvik Carvalho

LONDON, Feb 26 (Reuters) - The U.S. dollar rose against most major currencies on Friday, lifted by an increase in U.S. bond yields overnight, while the pound dropped to its lowest in over a week.

Government bonds, and particularly U.S. Treasuries, have become the focal point of markets globally. Traders have moved aggressively to price in earlier monetary tightening than the Federal Reserve and other central banks have signalled.

European stocks extended a global equity sell-off, with risk appetite souring as the surge in yields fomented inflation worries. Emerging-market and commodity-linked currencies continued to retreat Thursday. Cryptocurrencies stabilised after tumbling overnight.

The dollar move is "a function of what's happening on the yields side," said Jeremy Stretch, head of G10 FX strategy at CIBC World Markets. The 10-year yield briefly climbed above the S&P 500 dividend yield on Thursday, Stretch noted, indicating "uncertainty that is writ large".

"But I think we're going to continue to see central bankers pushing against the notion of earlier-than-expected policy reversal and that, alongside an unwind of some end-month uncertainty, will provide a more constructive backdrop for the high beta currencies versus the dollar into the start of next month," he said.

The dollar index edged up to 90.39, holding on to a 0.2% rise from Thursday, when it rebounded from losses of as much as 0.26% before a bond tender. That leaves it down less than 0.2% for the month, following January's 0.6% gain.

The dollar lost 0.1% to trade at 106.115 yen after earlier touching 106.43 for the first time since September. It has strengthened 2.8% this year after the first back-to-back monthly increases since mid-2018, putting the yen among the worst-performing major currencies in 2021.

Both the dollar and yen are considered haven currencies, but the yen tends to decline when U.S. yields rise, the dollar to strengthen.

Bond yields have climbed this year on the outlook for massive fiscal stimulus amid continued ultra-easy monetary policy, led by the United States.

An acceleration in the pace of vaccinations globally has also bolstered what has become known as the reflation trade, referring to bets on an upswing in economic activity and prices. Sterling, a huge beneficiary of the reflation narrative, hit its lowest in over a week to $1.3901, losing 0.6% to the dollar on the day.

In recent days, though, a rise in inflation-adjusted bond yields has accelerated, indicating a growing belief that central banks may need to pare back ultra-loose policies, despite their dovish rhetoric.

"The fixed income rout is shifting into a more lethal phase for risky assets," after initially being interpreted as a "story of improving growth expectations," Westpac strategists wrote in a client note.

"It appears to be the case that bond markets are 'taking on' the central bankers' world view, and standing in front of the current momentum is unwise."

The benchmark 10-year Treasury yield surged above 1.6% overnight for the first time in a year, after an auction of $62 billion of seven-year notes was met with weak demand.

The Australian dollar continued its retreat after topping $0.80 on Thursday for the first time since February of 2018, declining over 0.6% to $0.78050.

New Zealand's currency dropped 0.4% to $0.7336 after reaching $0.7463 Thursday, a level not seen since August 2017.

The Canadian dollar weakened 0.1% to C$1.2620 after falling from its own three-year top at C$1.2468 overnight.

The euro slid 0.3% to $1.2142 after touching a seven-week high of $1.22435 on Thursday.

Bitcoin slid 5% to $44713. Ethereum traded at $1,479 following a 9% drop.

(Reporting by Ritvik Carvalho; additional reporting by Kevin Buckland in Tokyo; editing by Larry King)

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