NEW YORK The yen fell to a more than two-year low against the U.S. dollar on Thursday on expectations of bold monetary stimulus in Japan, while the greenback slipped against the euro ahead of more talks in Washington to avert the "fiscal cliff."
The dollar has risen 12 percent against the yen in 2012, on track for its biggest annual gain since 2005. Yen selling has accelerated in the past two months on speculation Japan's new Prime Minister Shinzo Abe will pursue policies to weaken the Japanese currency.
"If everyone is simply going to take Mr. Abe at his word, then we can go a lot further before this move is done," said Kit Juckes, strategist at Societe Generale in London.
Traders said speculators and hedge funds were increasingly looking to sell yen for dollars. Some said a dollar close above its 200-week moving average of 84.95 yen on Friday - the first since late December 2007 - would be a strong signal of further strength in the U.S. currency.
The dollar rose to 86.15 yen on Reuters data, its highest since mid-August 2010. It was last up 0.5 percent at 86.02 yen. Investors took out option barriers at 86 yen and stop-loss buy orders above 86.10.
The euro rose 0.2 percent to $1.3242 (8223 pence). Against a basket of currencies, the dollar erased early gains to trade slightly lower at 79.590, still above a two-month low of 79.008 hit last week.
The U.S. House of Representatives will hold a work session on Sunday beginning at 6:30 p.m. EST (2330 GMT), a day before the December 31 deadline for reaching a deal that would avert automatic tax increases and spending cuts.
The dollar had earlier gained after the top Democrat in the U.S. Senate warned that the United States looks to be headed over the "fiscal cliff.
The greenback tends to benefit when there are snags in U.S. budget negotiations because it is highly liquid and perceived as a safe haven. Conversely, when talks are running smoothly, investors tend to buy currencies such as the euro and Australian dollar.
Should Congress fail to act by December 31, tax rates for all Americans would jump back to pre-2001 levels. Two days later, $109 billion (67 billion pounds) in automatic spending cuts would start to take effect. Together, the higher taxes and lower spending would suck about $600 billion (372 billion pounds) out of the U.S. economy, potentially causing a new recession in 2013.
MORE YEN WEAKNESS
In the options market, risk reversals in dollar/yen showed a further bias toward yen weakness. Risk reversals from one-month up to four-years were skewed toward dollar calls or yen puts, reflecting increased confidence among investors to bet against the Japanese currency.
One-month implied dollar/yen volatility, a gauge of expected moves, rose to 8.5 vols from 7.3 last week, close to the December 13 near-six-month high of around 8.65, highlighting growing demand to hedge against sharp price swings.
Abe, who has promised aggressive monetary easing by the Bank of Japan and steps to weaken the yen, appointed a cabinet of close allies on Wednesday. A weaker yen helps Japanese exports and has lifted Japanese stocks.
The euro rose 0.6 percent to 113.95 yen, having risen as high as 114.31 on Reuters data, the strongest since July 2011.
"Investors are looking to see whether the Bank of Japan will ease at its next policy meeting in January, and if it doesn't ease aggressively enough, then the new government could come, which would hurt the BoJ's independence," said Shaun Osborne, chief currency strategist at TD Securities in Toronto.
"There's limited scope for a yen rebound while the Abe government continues to threaten BoJ independence," he said.
(Additional reporting by Gertrude Chavez-Dreyfuss; Editing by Dan Grebler)