* Yen reverses gains after U.S. CPI data
* Investors expecting big LDP win in Japan election on Sunday
* Euro heads for biggest weekly gain vs dlr since late Nov
NEW YORK, Dec 14 (Reuters) - The dollar surrendered early gains and fell against the yen on Friday after a U.S. report on inflation showed prices fell in November for the first time in six months, which should allow the Federal Reserve to stay on its ultra-easy monetary policy path.
The Labor Department said on Friday its Consumer Price Index dropped 0.3 percent last month as a sharp decline in gasoline prices offset increases in other areas. It was also the largest drop since May and followed a 0.1 percent gain in October.
The Fed said on Wednesday it expected to hold interest rates near zero until unemployment falls to at least 6.5 percent and as long as inflation does not threaten to break above 2.5 percent and inflation expectations are contained.
“The inflation data continues to be benign and there is very little in the way of price pressures in the economy,” said Omer Esiner, chief market analyst at Commonwealth Foreign Exchange in Washington. “That therefore justifies the Federal Reserve’s action to keep a very accommodative monetary policy.”
The dollar fell 0.1 percent to 83.52 yen, having earlier risen as high as 83.96, its highest level since March 21. It was not far from its March 2012 peak of 84.187, which is seen as a major resistance level.
Traders cited an options barrier at 84 yen with the options market also showing increasing bias for more yen weakness with investors increasingly buying yen puts.
Bets that the yen will weaken have risen significantly as Japan looked set to get a prime minister keen to push for the central bank to print more money to stimulate the moribund economy.
Japanese media reported the conservative Liberal Democratic Party (LDP) is set for a resounding victory in elections on Sunday, cementing speculation LDP leader Shinzo Abe will be in a strong position to push for bold monetary easing.
But the negative momentum for the yen ended sharply with the U.S. CPI report which also spilled over into the euro’s moves against the yen.
The euro had climbed to an eight-month high of 109.98 yen , and remains on track to end the week around 2.5 percent higher on the yen. But after the U.S. inflation data, the euro slipped and was last at 109.24 yen, down 0.1 percent. Option barriers were reported at 110 yen.
“This inflation report indicates the Fed can continue to print as much money as it wants,” said Joseph Trevisani, chief market strategist at Worldwide Markets, Woodcliff Lake in New Jersey.
The dollar has risen 5.5 percent against the yen in the past month and there are technical signs the pair has risen too fast in a short period of time, with its 14-day relative strength index standing well above the “overbought” mark of 70.
Some said the yen may rally further next week if the Bank of Japan underwhelms investors at its next meeting. The BoJ is widely expected to loosen monetary policy, although there is scope for market players to be disappointed by the amount of assets it decides to purchase.
The euro was also on track for its biggest weekly gain against the dollar since the week ending November 25. It rose to a high of $1.3119, its highest level in more than a week though it surrendered most of those gains to trade little changed at $1.3074.
Traders cited central banks’ offers to sell at $1.3135/40 with reported option barriers at $1.3150 and $1.3200.