SYDNEY (Reuters) - The yen languished near 20-month lows against its U.S. peer on Thursday, but trading was choppy in thin conditions with yen bears possibly suffering a case of cold feet as the Bank of Japan's policy decision loomed.
Facing intense political pressure, the BOJ is likely to expand its 91-trillion-yen ($1 trillion) asset-buying and lending programme by 10 trillion yen and could consider adopting a 2 percent inflation target.
The prospect of more yen pouring into the economy has already helped drive the Japanese currency down almost 9 percent on the greenback since September.
The dollar stood at 84.16 yen, having risen as high as 84.62 overnight, a level not seen since April 2011. The euro fetched 111.14 yen after hitting a 16-month peak of 112.59.
"Pressure on the BOJ to act is strong," said Sebastien Galy, strategist at Societe Generale.
"At the same time, they will be keen on maintaining their credibility and insisting that the bigger problem is a fiscal one. The odds are that the BOJ may do enough not to frighten the markets too much, but leave major decisions to January."
With markets already very bearish on the yen, traders warned a lack of bold action could see short positions squeezed, leading to a sharp rebound in the Japanese currency.
"We may see the yen regain its footing over the next 24-hours of trading should Governor Masaaki Shirakawa take a greater stand in preserving the central bank's independence," said David Song, currency analyst at DailyFX.
The yen and U.S. dollar, both seen as safe haven currencies, saw a small reprieve after talks to resolve the U.S. fiscal impasse appeared to have taken a turn for the worse.
The Republicans announced plans to put an alternative tax plan to a vote in the House this week that would largely disregard the progress made so far in negotiations, prompting President Barack Obama to threaten to veto it should Congress approve.
"Democrats and Republicans continued to try to frighten each other into gaining the upper hand. They mostly managed to bring in a mild wave of profit taking in the markets," Galy added.
That saw the euro retreat to $1.3204 from an 8-1/2 month high around $1.3309. As a result, the dollar index bounced to 79.414 from 79.008.
The Australian dollar took a hit as well, slipping to one-week lows of $1.0470 to be more than a full cent below last week's three-month peak.
Also under pressure, the New Zealand currency slid to a near two-week low around $0.8329 after data showed the economy slowed more than expected in the third quarter.
Gross domestic product expanded a mere 0.2 percent in the quarter, half of market expectations, and following downwardly revised 0.3 percent growth in the second quarter.
"It means there's more chance of a rate cut than a hike in 2013, but our base case remains steady policy for a long time to come," said Michael Turner, strategist, RBC Capital Markets.
(Editing by Wayne Cole)