TOKYO - The dollar extended its sharp rally against the yen on Wednesday, although it was capped against the euro with a potentially supportive spike in U.S. yields neutralised by a similar move by their German counterparts.

The pound hovered within distance of a one-year high after a robust UK inflation report added pressure on the Bank of England to do more to support the currency.

The dollar was up 0.1 percent at 110.270 yen and at its highest in almost two weeks.

The greenback had slumped to a 10-month low of 107.320 yen on Friday, when Hurricane Irma threatened Florida and as financial markets braced for the possibility of another missile or nuclear test by North Korea to mark its founding on Sept. 9.

Risk aversion has ebbed significantly since, prompting a drive-up in U.S. Treasury yields to two-week highs and fuelling a comeback by the dollar.

"Dollar/yen shows the highest correlation to U.S. yields and the pair is benefiting from the latest rise in yields. Covering of dollar short positions created by macro-driven funds has been rapid and aggressive under such conditions," said Yukio Ishizuki, senior currency strategist at Daiwa Securities.

"North Korean concerns are on a lower boil for the moment and the U.S. debt ceiling issue can be put aside now for the rest of this month. Dollar-negative factors are suddenly decreasing."

The euro was steady at $1.1967 after edging up 0.1 percent overnight.

While the U.S. 10-year Treasury note yield rose about 5 basis points overnight, its German bund counterpart jumped nearly 7 basis points, helping prevent the dollar from gaining on the euro.

German bund yields have risen as safe-haven government debt came under pressure from a respite in North Korea tensions.

Sterling was little changed at $1.3286 following its ascent to $1.3300 overnight, its highest in a year.

Data on Tuesday showed British inflation rose to 2.9 percent in August from a year earlier, more than forecast and above the BoE's 2 percent target.

The inflation jump is seen complicating the job of policymakers in explaining why they are not raising interest rates. The BoE holds a policy meeting on Thursday.

The dollar index against a basket of six major currencies was flat at 91.882 after closing Tuesday a shade lower. It has managed to remain above the 2-1/2-year low of 91.011 plumbed on Friday. (Reporting by Shinichi Saoshiro; Editing by Shri Navaratnam)

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