* Dollar/yen hits 2 1/2-yr high, euro/yen hits 21-month peak * Euro rises as European banks prepare to repay ECB cash * German Ifo helps euro, steady demand for euro calls By Anirban Nag LONDON, Jan 25 (Reuters) - The euro hit an a 11-month high against the dollar and a 21-month peak against the yen on Friday, on evidence of an economic upturn in Germany and signs the euro area banking system may be on the mend. Sentiment towards euro zone assets has picked up in recent weeks and investors have positioned for European banks to repay part of the ultra-cheap three-year loans the European Central Bank extended in late 2011 and early 2012. A willingness to hand back the loans would be considered a signal that the struggling banking system is stabilising, and would provide a boost to the euro in coming weeks, analysts said. The ECB will announce at 1100 GMT how much of the 1 trillion euros it lent out to banks they intend to pay back next week, with repayments of about 100 billion euros forecast. That would lead to some shrinking of the ECB's balance sheet at a time when the U.S. Federal Reserve and the Bank of Japan are still expanding theirs. Balance sheet expansion by a central bank usually hurts a currency as it increases its supply. Investors were also cheered by better-than-expected German business morale. The influential Ifo survey beat expectations, just as the country's ZEW survey and Purchasing Managers Index did earlier this week. The index was at 104.2 in January compared with a forecast of 103. "The Ifo number has been supportive of the euro and investors want to go long," said Geoffrey Yu, currency strategist at UBS. "It's all about momentum now, and data like this only helps." The euro was up 0.6 percent at $1.3449, an 11-month high but with near-term resistance expected around its February 2012 high of $1.3486. Against the yen, the euro was 1 percent higher at 122.19 yen - its highest since mid-April 2011. The euro has gained nearly 1 percent against the dollar and 1.7 percent against the yen this week as investors bet on more gains, given falling euro zone peripheral bond yields and as the ECB prepared to rein in one of its unconventional monetary policy settings. "We are bullish about the euro and expect it to rise past $1.35 in the coming weeks," said George Saravelos, G10 FX strategist at Deutsche Bank. "While the pre-payment to the ECB will be spread out, we think it is supportive for the euro because the ECB's balance sheet will be shrinking." In the options market, traders reported steady demand for euro calls - or bets on more gains. The one-month risk reversals traded at 0.2 vols in favour of euro calls, having flipped from euro puts. YEN WEAKENS The yen was under renewed pressure after reports on Thursday quoted Japan's deputy economy minister as saying the yen's decline was not over, and that a dollar/yen level of 100 would not be a concern. The dollar rose to a 2-1/2 year high of 90.92 yen, rising past an option barrier at 90.75 with more barriers cited at 91 yen. The U.S. currency has gained more than 14 percent since mid-November. "Every time dollar/yen has a correction, it seems that one or other Japanese official comes out and talks the (Japanese) currency down," said Callum Henderson, global head of FX research for Standard Chartered Bank in Singapore. "Undoubtedly, there is a campaign on the part of the Japanese authorities to continue to focus the market's attention on the need to reflate the economy." The yen's steep drop since late last year and government efforts to ease fiscal and monetary policy have raised eyebrows abroad, with German Chancellor Angela Merkel singling out Japan on Thursday as a source of worry. Japanese Finance Minister Taro Aso, shrugging off the concerns, said on Friday the monetary easing was aimed at pulling the country out of deflation, not manipulating currencies.