FOREX-U.S. dollar, yen gain as risk sentiment worsens

* Yen, dollar extend gains as weak PMIs knock share markets

* High-yielders sink on expectations of global rate cuts

* BoE, ECB, RBA, RBNZ all seen slashing borrowing costs (Updates prices, adds comments, changes byline, dateline; previous LONDON)

By Gertrude Chavez-Dreyfuss

NEW YORK, Dec 1 (Reuters) - The U.S. dollar and yen gained on Monday as sharp declines in Chinese and European manufacturing activity unnerved investors and pushed stock markets worldwide lower.

The currencies have rallied over the last few months as investors reversed risky trades funded by cheap yen and dollar borrowings. Investors have also sought dollars as they pinned their hopes on a substantial economic stimulus package from the incoming Obama administration.

The yen performed best against currencies of countries where central banks are expected to slash interest rates later this week, including the euro, sterling and Australian dollar.

"This is a classic flight-to-safety reaction fueled by further signs of a deteriorating global economy," said Omer Esiner, senior market analyst, at Ruesch International in Washington.

"Specifically, the dramatic slowdown in European, UK, and Chinese manufacturing have pressured stock markets around the world, including U.S. stock futures. These are all supportive of safe-haven bids in the dollar and the unwinding of carry trades, which has helped the yen," he added.

In early New York trading, the dollar was down 1.6 percent against the yen at 94.00 yen. The euro also fell against the yen, dropping 2.3 percent to 118.37 yen.

The euro fell 0.8 percent against the dollar to $1.2597, while the ICE Futures' dollar index rose 0.5 percent to 87.147.

Falls in the euro and other European currencies accelerated after manufacturing activity in the euro area, which has already entered recession, hit a record low in November.

China also saw its manufacturing industry slump in November as new orders, especially from abroad, tumbled. The resulting risk aversion took global share prices, as measured by MSCI's all-country index, down more than 1 percent on the day.

Sterling was off 2.9 percent against the greenback at $1.4951. Sterling's losses were exacerbated after British figures showing manufacturing activity had shrunk at a record pace.

DEFLATION THREAT

The Bank of England, the European Central Bank, the Reserve Bank of Australia and the Reserve Bank of New Zealand are all expected to cut rates by at least half a percentage point, diminishing the yield advantage of their currencies over the ultra-low yielding yen.

Analysts expect those four central banks to cut rates aggressively to counter the threat of deflation and prevent the global financial market crisis from further undermining the economy.

"Evidence continues to build suggesting that these central banks have further aggressive monetary easing to undertake in order to stem the risks of a dramatic shift in price expectations going forward," said Bank of Tokyo Mitsubishi in a research note.

Yen crosses reflected those expectations, with sterling/yen, Australian dollar/yen and New Zealand dollar/yen all down more than 3 percent on the day.

Analysts expect the RBA to cut its benchmark cash rate by 75 basis points to 4.50 percent on Tuesday, while the RBNZ is expected to slash a full 1.5 percentage points off its key rate to 5 percent, which would match the magnitude of the Bank of England's surprise cut last month.

Economists polled by Reuters expect the BoE to follow that up with a more modest 50 basis point cut to 2.5 percent on Thursday and the ECB is expected to cut by half a percentage point on Thursday to 2.75 percent.

Investors will be keeping an eye on the November jobs report on Friday. Later on Monday the Institute for Supply Management releases its November manufacturing index. (Additional reporting by Veronica Brown in London; Editing by Tom Hals)