* Dollar/yen down from highest since Aug 2010 set on Friday
* But greenback still up nearly 12 pct vs yen in 2012
* Near-term focus on U.S. fiscal cliff negotiations
By Masayuki Kitano
SINGAPORE, Dec 31 (Reuters) - The yen held above a two-year low versus the dollar on Monday but remained on track for its largest annual drop in seven years, pressured by expectations for more forceful monetary easing by the Bank of Japan.
The dollar last stood at 86.13 yen, staying below Friday’s high of 86.64 yen, which was the greenback’s strongest level versus the Japanese currency since August 2010.
As the year draws to a close, the dollar is up about 11.9 percent against the yen for 2012, putting it on track for its biggest percentage gain versus the Japanese currency since 2005.
With a new Japanese government led by Prime Minister Shinzo Abe expected to pursue a policy mix of aggressive monetary easing and heavy fiscal spending to beat deflation, analysts see the yen staying under pressure in 2013.
A near-term focal point, however, is whether U.S. lawmakers can hash out a last-minute deal to avoid the “fiscal cliff” of $600 billion in tax increases and spending cuts that are set to take effect from early January.
Efforts to prevent the U.S. economy from tumbling over the fiscal cliff stalled on Sunday as Democrats and Republicans remained at loggerheads in their talks.
After adjourning for the day, the U.S. Senate was set to reconvene on Monday, leaving just hours to pass any deal that may emerge through both chambers of a bitterly divided Congress.
“If things stay the way they are, there will be little choice but to see a ‘risk-off’ move starting from Jan. 2,” said Satoshi Okagawa, senior global markets analyst for Sumitomo Mitsui Banking Corporation in Singapore.
The yen could push higher in the short term due to the concerns about the U.S. fiscal cliff, Okagawa added.
Market players have been fretting that equities and other risky assets may come under pressure if U.S. lawmakers fail to reach an agreement before Jan. 1.
Such a broad retreat from risk-taking could bolster the dollar against currencies such as the euro and the Australian dollar. In times of market turbulence, investors often flock to the greenback, which is regarded as a safe haven because it is highly liquid.
The euro slipped 0.1 percent to $1.3201, inching away from an 8-month high of $1.33085 hit on Dec. 19.
Against the yen, the euro held steady at 113.685 yen , down from a 17-month high of 114.675 yen set on Friday. The euro has risen roughly 14 percent against the yen in 2012, putting it on track for its biggest yearly percentage gain versus the yen since the euro was launched in 1999.
The Australian dollar rose 0.1 percent to $1.0384, but was still not too far from a one-month low of $1.0345 set last week.
The yen may be due for a bounce in the near term, especially since currency speculators have already ramped up bearish bets against the Japanese currency, said Roy Teo, FX strategist for ABN AMRO Bank in Singapore.
Data from the U.S. Commodity Futures Trading Commission showed that currency speculators slightly trimmed back their bearish bets against the yen in the week to Dec. 24.
Even then, the amount of their net short positions in the yen was only slightly below the highest level in more than five years that had been hit earlier in December.
With the Japanese government pressing the Bank of Japan to set a 2 percent inflation target -- double the central bank’s current target -- any drop in the dollar against the yen is likely to be fairly limited, said Teo at ABN AMRO Bank.
“I think any dips in dollar/yen, there will be some support towards the 82 yen level,” he said, adding that the dollar was likely to be supported versus the yen ahead of the BOJ’s next policy meeting on Jan. 21-22.
In an interview with Japan’s Nikkei newspaper published on Saturday, BOJ Governor Masaaki Shirakawa said the central bank needs to maintain flexibility in monetary policy if it were to adopt the 2 percent inflation target sought by the country’s new prime minister, given the potential risks of such a move.