* Euro extends gains after bouncing on report of ECB policy change
* Euro zone bond yields at 2-week highs
* Sterling dips below $1.27 to 31-year low (Recasts, adds details)
By Anirban Nag
LONDON, Oct 5 (Reuters) - The euro soared to a five-year peak against the struggling pound on Wednesday and scaled a three-week high against the yen, bolstered by rising euro zone government bond yields.
Euro zone bond yields rose to two-week highs in early trade, with investors on edge a day after a Bloomberg article cited sources as saying the central bank would probably wind down its bond buying gradually before ending quantitative easing.
However, an ECB media officer said in tweet later on Tuesday that the ECB had not discussed reducing the pace of its monthly bond buying.
Nevertheless, rising German bund yields saw rate differentials move in favour of the euro, giving it a leg up so that it was 0.4 percent higher against the pound at 88.31 pence , a level last seen five years ago, and at 115.545 yen, its highest in three weeks.
The euro was also 0.2 percent higher against the dollar at $1.1226.
“The headlines that the ECB is considering tapering has led to some buying in the euro, especially against the yen,” said Yujiro Goto, currency strategist at Nomura. “We do not think the ECB is anywhere close to tapering its asset purchase programme, but in the near term momentum is towards euro upside.”
The single currency had been kept relatively subdued against the dollar in the past few months as the ECB has been easing extensively while the Federal Reserve is poised to raise rates in coming months.
“It remains to be seen if the report can be substantiated. But the mood in the market appears to have shifted with the mention of ECB tapering as it would spell an end to monetary policy divergence,” said Masashi Murata, senior currency strategist at Brown Brothers Harriman in Tokyo.
The euro’s rise saw the dollar retreat from near a two-month high against a basket of currencies. The greenback had been on a strong footing after rallying at the start of the week on an upbeat survey of the U.S. manufacturing sector.
It got an additional lift after Richmond Federal Reserve President Jeffrey Lacker said on Tuesday there was a strong case for raising interest rates and as Treasury yields rose to two-week highs in response to a surge by their euro zone counterparts.
The dollar index was down 0.15 percent at 96.038, having risen to 96.442 on Tuesday, its highest since Aug. 9. It was slightly lower at 102.77 yen after rising to a three-week high of 102.965 on Tuesday, when it posted its sixth straight day of gains versus its Japanese peer.
Meanwhile, the sterling fell below $1.27 for the first time in over three decades amid worries that Britain’s separation from the European Union could be rocky and have adverse economic consequences. (additional reporting by Shinichi Saoshiro; Editing by Raissa Kasolowsky)