FOREX-Yen sell-off abates, but gains may prove fleeting

* Yen selling eases a bit, but more downside seen

* Risk reversals favour yen calls

* Euro eyes Italian govt bond auction

LONDON, March 13 (Reuters) - The yen rose for a second straight day on Wednesday, trading above a 3-1/2-year low versus the dollar, helped by a bout of profit taking by investors who had placed hefty bets against it recently.

But the bounce will give hedge funds and long-term investors a fresh opportunity to rebuild positions against the Japanese currency, given strong expectations of aggressive monetary policy easing from the Bank of Japan in coming months would weaken the yen.

The Japanese parliament is expected later this week to sign off on the nomination of a dovish former currency diplomat Haruhiko Kuroda as BOJ's next chief. Kuroda has vowed to pursue radical measures to lift Japan's inflation rate to two percent - something that has not happened for almost two decades.

The nomination for academic Kikuo Iwata, an arch dove, for one of the two vacant deputy governor posts and about whom there was some opposition, is also likely to go through.

The dollar was down 0.3 percent at 95.80 yen, having scaled a 3-1/2-year peak of 96.71 yen on Tuesday, where it had brought its year-to-date gains to more than 10 percent. Traders said there were dollar bids at 95.10/20 yen by investors betting on the U.S. currency regaining some of its lost ground.

"We have seen some profit taking in dollar/yen which has helped the yen recover ground," said Adam Myers, European head of FX strategy at Credit Agricole. "But with the nomination process likely to go through, even for Iwata, we could see that end and dollar/yen will resume its uptrend."

In one telling sign that the relentless selling pressure on the yen since last November may be easing, risk reversals, which gauge relative demand for put and call options, flipped towards yen calls or bets that the currency will gain.

The one-month risk reversals was traded at 0.1 vols in favour of yen calls, flipping from around 0.5 in favour of yen puts just last week. The three-month risk reversal was at 0.05 vols in favour of yen calls while the one-year was also showing a bias for yen strength.

"This flip in risk reversals shows banks' option desks are short of yen calls at a time when their customers want them," said Credit Agricole's Myers.

ITALY, US RETAIL SALES

Meanwhile, the euro was steady at $1.3035, well within the $1.2955-3135 range seen so far this month, and off its recent three-month low of $1.2955.

Investors were waiting for the outcome of government bond sales in Italy for fresh cues. Italy will offer three-year and 15-year bonds at an auction later on Wednesday, and a good response could give the euro a lift.

Morgan Stanley said in a morning note that while the Italian bond market has been the laggard, prices have now risen for almost two weeks, pointing to less funding stress for the euro zone's third-largest economy.

"The correlation between Italian bond prices and the performance of euro/dollar has remained intact, suggesting the euro will rally in the near term," the note said.

A steady euro and the yen's pullback kept the dollar index off its seven-month high hit last week following strong U.S. payrolls data. The dollar index stood at 82.510, down 0.1 percent on the day and below Friday's peak of 82.924.

Focus will be on U.S. retail sales data due at 1230 GMT.

While a strong reading could fuel speculation that the U.S. Federal Reserve may wind up its stimulus, some traders also say the market's expectations of an end in the Fed's quantitative easing might be premature.

"It is not like the Fed will exit from the QE at its next policy meeting. It's true the Fed board members are debating it but a lot of voting members on the Fed's policy board are dovish," said Katsunori Kitakura, associate general manager of market making at Sumitomo Mitsui Trust Bank.