By Ankur Banerjee and Linda Pasquini

SINGAPORE/LONDON (Reuters) -The yen bounced on Friday, recovering earlier losses, after Japan’s former defence minister Shigeru Ishiba won the leadership contest of the country’s ruling Liberal Democratic Party and was set to become its next prime minister.

Ishiba is a critic of past monetary stimulus and told Reuters the central bank was “on the right policy track” with rate hikes thus far.

The yen gained about 1% to 143.44 yen per dollar, from 146.49 earlier in the day, its weakest since Sept. 3.

Markets had braced for the victory of hardline nationalist Sanae Takaichi, a vocal opponent of further interest rate hikes, in one the country’s most unpredictable leadership votes in decades.

“(Ishiba’s victory is) a surprise to the market, which seems to have been bracing for a Takaichi victory,” analysts at UBS said.

The yen rallied broadly, rising sharply against the euro, which fell 1.27% to 159.83.

Marcel Thieliant, head of Asia-Pacific at Capital Economics, noted that Ishiba had sounded more cautious recently, saying his country had yet to fully overcome inflation.

“The sharp strengthening of the yen following Ishiba’s victory underlines that markets view his victory as clearing the way for further rate hikes,” Thieliant said.

“To be sure, our own analysis shows that the government has less sway on monetary policy decisions than commonly thought. Nonetheless, his victory will probably be greeted with relief by BOJ policymakers,” he said.

Elsewhere, the euro was down 0.45% at $1.1127 after data showed inflation in France and Spain rose less than expected, prompting traders to ramp up their bets on an October rate cut from the European Central Bank.

“And yet euro-dollar is still holding well above that $1.11 handle,” said Jane Foley, senior forex strategist at Rabobank, highlighting the resilience of the euro, which hit 14-month highs earlier this week.

It is going to be an “interesting few days” for the euro, she said, given inflation data early next week and the focus on potential ECB rate cuts ahead.

The derivatives market showed traders were attaching an almost 80% chance of a cut when the ECB meets next month, while a week ago, the chances were negligible.

Meanwhile, China’s spree of stimulus measures this week continued to boost risk appetite, lifting stocks, commodities and risk-sensitive currencies.

Steps so far have included lowering the amount of cash banks must hold as reserves by 50 basis points to free up more funds for lending and a slew of cuts in key interest rates.

Moreover, China’s leaders pledged on Thursday to support the struggling economy through “forceful” interest rate cuts and adjustments to fiscal and monetary policies, stoking expectations for more stimulus.

Sterling was a shade lower at $1.3367 but remained close to this week’s 2-1/2 year high, while the Australian and New Zealand dollars also held near multi-year highs due to China stimulus plans.

DRIFTING DOLLAR

Data on Thursday suggested the U.S. labour market remained fairly healthy, while other reports showed corporate profits increased at a more robust pace than initially thought in the second quarter.

The dollar, however, remained on the back foot as traders priced in 73 basis points (bps) of easing for the rest of the year, with a 51% chance for another outsized 50-bp cut, according to CME Group’s FedWatch Tool.

The Federal Reserve has recently signalled a shift in focus away from inflation and towards the labour market, delivering a larger-than-usual 50 bps rate cut last week.

The dollar index, which measures the greenback against a basket of six currencies, was last at 100.7, not far from Wednesday’s 14-month low of 100.21.

Investors will keep an eye on the personal consumption expenditures price index due later on Friday, but analysts do not expect it to materially shift market pricing for U.S. rates unless there is a huge miss.

(Reporting by Ankur Banerjee in Singapore and Linda Pasquini and Samuel Indyk in London; Additional reporting by Vidya Ranganathan Editing by Jamie Freed, Kim Coghill, Sonali Paul, Amanda Cooper, Alex Richardson and Timothy Heritage)

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