(Corrects yen's direction in lede)
* Rapid drop vs yen leads to speculation of Japan intervention
* 1-Month Dollar/yen volatility soars to highest since June 2013
By Lisa Twaronite
TOKYO, Feb 12 (Reuters) - The dollar fell on Friday headed for steep weekly losses, as investors braced for another day of cratering sentiment and waited to see whether Japan would act to stem its currency's rise.
Japanese markets were closed for a public holiday on Thursday, when the dollar fell as low as 110.985 yen, its lowest level since October 2014. It last stood at 112.05 yen, down 0.3 percent and on track to shed over 4 percent for the week.
The yen's recent rapid ascent followed the Bank of Japan's move to adopt negative interest rates on Jan. 29, under which banks have to pay interest on certain deposits held at the BOJ. The dollar hit a high of 121.70 yen, before risk aversion, slowing Chinese growth and falling crude oil prices sent investors into perceived safe-haven currencies.
"The BOJ's negative interest rate policy has less effect on encouraging more liquidity by banks but more side effects on the market," said Shinichi Kashiwagi, head of market sales at National Australia Bank in Tokyo.
"There is not much the BOJ can do unless outside factors become stable," he said.
The dollar's overnight jump back above the 112-yen level led to speculation that Japanese authorities were checking currency rates, a step that often precedes intervention.
A government official declined to comment on intervention on Friday.
"Recent exchange-rate moves have been rough. We're closely watching currency market moves with a sense of urgency," the official said, on the condition of anonymity.
Japanese Finance Minister Taro Aso escalated his rhetoric, saying Japan would take appropriate actions as needed, and said he hopes the Group of 20 finance leaders gathering in Shanghai later this month will consider a global policy response in the wake of the recent market turmoil.
"It now appears that 110 is the line in the sand for the central bank and while that rate seemed far away a few days ago, the currency pair came very close to testing that level last night," Kathy Lien, managing director of BK Asset Management in New York, said in a note to clients.
"Even though we are trading above that rate now, the risk of intervention is significant," she said.
One-month dollar/yen implied volatility - an indicator of how much currency movement is expected in the weeks ahead - surged to 15.9 percent, its highest since June 2013 and nearly twice as high as 8.27 percent recorded earlier this month.
Federal Reserve Chair Janet Yellen did little to help the greenback in her second day of testimony before U.S. lawmakers.
While she said she still expects the central bank to gradually hike interest rates this year as the labour market and economy continue to improve, she reiterated that policymakers were not on a "pre-set" path to return policy to "normal" given a worsening meltdown in global stock markets.
The euro was steady at $1.1325, within sight of its overnight high of $1.1377, its highest since October 2015, and on track for a weekly gain of 1.5 percent.
The dollar index, which gauges the U.S. unit against a basket of six major currencies, slipped about 0.1 percent to 95.465, poised for a 1.5 percent loss, after skidding to a low of 95.236 overnight, its lowest since October. (Editing by Michael Perry)