* Yen hits 2-yr low vs dollar, lowest since Aug 2011 vs euro
* Dollar/yen on track to end above 200-week moving average
* Risk reversals skewed towards more yen weakness
* U.S. "fiscal cliff" stalemate supports dollar
By Anooja Debnath
LONDON, Dec 27 The yen fell to its lowest against the dollar in more than two years on Thursday, on expectations a new government in Tokyo will push for aggressive monetary stimulus and take steps to weaken the currency.
The dollar rose to 85.87 yen on trading platform EBS, its highest since September 2010. It was last up 0.2 percent on the day at 85.81 yen with option barriers cited at 86 yen and stop loss buy orders above 86.10 yen.
Speculators and hedge funds were increasingly looking to sell yen for dollars, traders said. 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 present yen weakness is related to the new government, which seems devoted to push through both fiscal and monetary policy changes and take direct measures to weaken the yen," said Richard Falkenhall, currency strategist at SEB in Stockholm.
"Yen weakness could very well continue. We see the yen as extremely over-valued considering the weak fundamentals we see in Japan."
Prime Minister Shinzo Abe, who has threatened to revise a law guaranteeing the Bank of Japan's independence if it refuses to set a 2 percent inflation target, appointed a cabinet of close allies on Wednesday.
The yen has fallen around 10.5 percent versus the dollar in 2012, its biggest annual drop since 2005, with most of that weakness coming in the past two months as expectations mounted that Abe will pursue policies to weaken the yen. A weaker yen helps Japanese exports and has already lifted Japanese stocks.
Japan's benchmark Nikkei share average hit a 21-month high on Thursday and has climbed 22 percent this year, putting it on track for its best yearly gain since 2005.
In the options market, risk reversals in dollar/yen showed a further bias towards yen weakness. Risk reversals from one-month up to four-years were skewed towards dollar calls or yen puts, reflecting increased confidence among investors to bet against the Japanese currency.
"There is quite a lot of bullishness within the market," said Saeed Amen, FX strategist at Nomura. "I don't anticipate any significant dips in dollar/yen. Even if there is one it would be bought into and will likely be shallow."
One-month implied dollar/yen volatility, a gauge of expected moves, rose to 8.5 vols from 7.3 last week, close to the Dec. 13 near-six-month high of around 8.65, highlighting growing demand to hedge against sharp price swings.
The yen touched its lowest level against the euro in nearly 17 months. The euro rose hit 113.90 yen, its strongest against the yen since early August of 2011.
The euro traded at $1.3271, up almost 0.4 percent on the day and just below an eight-month high of $1.33085 hit last week. Speculators further trimmed short bets against the single currency as euro zone debt worries ebbed.
But concerns the U.S. Congress might fail to head off a potentially recession-inducing "fiscal cliff" of tax hikes and spending cuts that are due to kick in next year could cap the single currency's gains.
Strategists said the impasse would support the dollar, which gains in times of uncertainty because of its high liquidity.
"Uncertainty around the fiscal cliff will be dollar positive and euro negative, as risk appetite decreases," said SEB's Falkenhall. "This (situation) will drag on until the last minute and probably even into February next year."
The dollar index stood at 79.423, above a two-month low of 79.008 hit last week.