* 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
* Sterling hits fresh high vs dollar, yen
* Fall in Abe's popularity could pose threat to Abenomics
By Ian Chua and Hideyuki Sano
SYDNEY/TOKYO, Dec 10 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
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.