* Euro extends recent gains on dollar and yen
* Mersch plays down prospect of ECB going QE
* Fed’s Bullard talks about possibility of small taper this month
* Sterling hits fresh high vs dollar, yen
* Fall in Abe’s popularity could pose threat to Abenomics trade
By Ian Chua and Hideyuki Sano
SYDNEY/TOKYO, Dec 10 (Reuters) - The euro stayed well-bid on Tuesday, scaling a fresh five-year high on the yen and a six-week peak against the dollar as expectations for further stimulus from the European Central Bank continued to fade.
ECB Executive Board member Yves Mersch on Monday played down the prospect of following the Federal Reserve and Bank of Japan down the path of asset purchases, saying such action poses immense challenges for the central bank.
In fact, the ECB’s balance sheet has been shrinking over the past year as the euro zone’s financial system stabilises, in contrast to the Fed and the BOJ which continue to print money through asset purchases.
That provides underlying support for the common currency, as does the euro zone’s current account surplus, despite sluggish economic growth in the currency bloc.
The euro last traded at 141.95 yen after touching 142.085, a high not seen since October 2008. Against the dollar, the common currency bought $1.3755, up slightly from late U.S. levels and creeping ever closer to a two-year high of $1.3833 set in late October.
The euro has been gaining ground since the ECB last week refrained from following up November’s surprise rate cut and said it has yet to come up with a detailed plan of which policy tools to use and when.
At the same time, there appears to be a general acceptance among investors that the Federal Reserve will soon scale back its bond-buying programme as the economy continues to improve.
Indeed, Dallas Fed President Richard Fisher, seen as a hawk, said financial markets are in a “better position to accept” a reduction in stimulus than they have been before.
More surprising for some traders were comments from centrist policymaker James Bullard, the St. Louis Fed president, who said the Fed could slightly reduce its monthly bond purchases this month in reaction to signs of an improved labour market. The Fed holds its policy meeting next week.
“That to me signals that when taper does happen it will be a token of faith to the markets,” said Evan Lucas, a market strategist at IG in Melbourne.
“I believe that any moves in the asset purchase programme will be a token affair as its second mandate of inflation is still well behind expectations.”
Economists polled by Reuters on Monday suspect the Fed will begin reducing its massive bond-buying programme in March, but some are warming up to the idea of a December or January taper.
Traders said markets have pretty much priced in the risk of the Fed scaling back support soon, which might help explain why the dollar has not risen broadly in the past few sessions.
In fact, a robust euro has knocked the dollar index to its lowest level in six weeks.
Against the yen, though, the greenback held at 103.22 yen and was close to a five-year peak of 103.74 set in May.
The Japanese currency continues to be the funding currency of choice thanks to the BOJ’s ultra-loose monetary policy and expectations of more easing next year when tax hikes kick in.
But one possible concern for yen bears is that support for Japanese Prime Minister Shinzo Abe dropped after he steamrolled through parliament a tough secrecy act that critics fear could muzzle media and allow officials to hide misdeeds.
“Given that investors have piled up huge yen-selling and Japanese share-buying positions solely on hopes of Abenomics, there is risk of reversal in these positions should Abe lose popularity,” said Junya Tanase, chief FX strategist at JPMorgan Chase Bank in Tokyo.
Another standout currency was sterling, which hit a two-year high against the dollar and a five-year peak against the yen, thanks to a brightening outlook for the UK economy.
Bank of England Governor Mark Carney said on Monday the country’s economic recovery is on its way to achieving self-sustaining momentum.
Still, Carney said monetary policy will need to remain exceptionally loose for some time to come, although sterling bulls paid no heed to that.
The pound rose as high as $1.6468, surpassing a two-year high of $1.6443 set a week earlier It last traded at $1.6455 , up 0.15 percent from late U.S. levels. Sterling also jumped to around 169.91 yen.
The focus in Asia is likely to rest on China’s industrial output and retail sales due around 0530 GMT.
Recent data has given hope the world’s second-biggest economy is regaining some momentum since arresting a protracted slowdown in the middle of the year. Confirmation of that view will help underpin risk appetite.