* U.S. markets slip as retailers hit
* Yen at 2-year low vs dollar, 16-month low against euro
* Retail sales fall short of expectations, shares down
By David Gaffen
NEW YORK, Dec 26 (Reuters) - The yen fell to a two-year low against the dollar on Wednesday as Japan's new prime minister called for weakening the currency to stimulate inflation, while U.S. stocks fell, led by declines in retailers' shares.
Sales growth at U.S. retailers was projected to have fallen short of expectations during the holiday shopping season, according to preliminary estimates from firms that track retail spending.
The S&P 500 was down 0.55 percent, with consumer discretionary stocks among the hardest-hit. The Morgan Stanley Retail index dropped 1.8 percent.
U.S. shares were also pressured as it appeared Congress will not negotiate a deal before Jan. 1 to avoid the "fiscal cliff," a series of $600 billion in spending cuts and tax hikes that would slow the U.S. economy sharply unless lawmakers take action.
There is concern that potential tax hikes cut into U.S. holiday spending.
"I think people held back this year, just worried about that bigger cut out of their paycheck next year and having to tighten their belt," said Janna Sampson, co-chief investment officer of OakBrook Investments in Lisle, Illinois. "If you've got to tighten your belts starting in January, people start worrying about overspending."
A U.S. official said on Tuesday that President Barack Obama may return to Washington from his Hawaiian holiday as early as Wednesday evening to resume talks.
A series of big decisions will wait until early 2013, when tax rates are scheduled to rise for most Americans. Economists warn that the world's largest economy could fall into recession as a result unless action - even retroactive - is taken to cushion the blow of higher rates and reduced spending that has helped bolster a weak economy.
The Dow Jones industrial average dropped 52.66 points, or 0.40 percent, at 13,086.42. The Standard & Poor's 500 Index was down 8.77 points, or 0.61 percent, at 1,417.89. The Nasdaq Composite Index was down 24.22
U.S. stocks have held in a tight range, recovering losses sustained just after the U.S. election in November. The S&P 500 is still up about 13 percent on the year.
The dollar rose as high as 85.74 yen on trading platform EBS, the highest since September 2010, following the swearing-in of Shinzo Abe as premier and was last at 85.65. The euro rose as high as 113.40 yen, a 16-month high, up 1.4 percent. The euro was at $1.3225 against the dollar, up 0.3 percent.
Abe is calling for a mix of aggressive monetary policy easing and big fiscal spending to beat deflation and weaken the yen. He is pressuring the Bank of Japan to adopt a 2 percent inflation target that would auger for a weaker currency, threatening changes at the central bank if his wishes are not met.
"The election of Abe has had a galvanizing effect on the dollar/yen exchange rate and he has been able to accomplish more in two months of jawboning than the BoJ has... over the past several years," said Boris Schlossberg, managing director of FX strategy at BK Asset Management in New York.
Many markets remained closed following Christmas. European exchanges were largely shuttered, and Hong Kong and Australia were also closed. The MSCI All-World Index was down 0.25 percent on Wednesday.
U.S. single-family home prices rose in October for the ninth month in a row. The S&P/Case Shiller composite index of 20 metropolitan areas gained 0.7 percent in October on a seasonally adjusted basis, stronger than the 0.5 percent rise forecast by economists polled by Reuters.
Ten-year U.S. Treasury notes rose 6/32 of a point in price to yield roughly 1.7546 percent. The U.S. bond market was closed on Tuesday for Christmas.
Brent crude climbed above $110 per barrel on Wednesday, hitting a two-month high, with investors hoping for a last-minute deal to avoid a U.S. fiscal crisis. U.S. crude futures gained $2.25, or 2.6 percent, to $90.86.
The weaker yen has bolstered hopes for better earnings from Japanese companies and underpinned the Nikkei, which has gained about 18 percent since mid-November, when the election was scheduled. The yen has lost nearly 8 percent against the dollar in the same period.
The Nikkei closed at a nine-month high on Wednesday, with a 1.5 percent gain.
Minutes of the BOJ's policy-setting meeting in November, released on Wednesday, showed that some board members said the central bank must act decisively, without ruling out any policy options, if the outlook for the economy and prices worsens further.
MSCI's broadest index of Asia-Pacific shares outside Japan was little changed. Shanghai shares were flat, but stayed in positive territory on the year after a 2.5 percent jump on Tuesday erased 2012 losses. It is set for a first annual gain in three years.