* Yen hits lowest level vs euro since August 2011
* BOJ kicks off 2-day meeting, expected to ease policy
* Progress in U.S. fiscal talks boost hopes of a deal
* Euro inches higher after German Ifo survey
By Nia Williams
LONDON, Dec 19 (Reuters) - The yen hit a 16-month low against the euro on Wednesday, dragged down by expectations the Bank of Japan will unveil more monetary stimulus when its two-day policy meeting ends on Thursday.
The euro climbed to its strongest level against the yen since August 2011 and also touched a 7-1/2 month high versus the dollar, as tentative signs of progress in U.S. budget talks helped improve market sentiment.
Some analysts warned any BOJ measures may fall short of market expectations however, which could prompt some investors to buy back the yen.
“Markets are getting pretty excited about tomorrow’s BOJ announcement, rightly or wrongly. Profit-taking either into the BOJ or directly after makes sense both in dollar/yen and the Nikkei,” said Geoff Kendrick, FX strategist at Nomura, who said the BOJ was more likely to take strong measures in 2013.
The euro hit a 16-month peak of 111.78 yen, before pulling back to trade up 0.2 percent on the day at 111.61 yen.
Market players also cited year-end demand for the euro from corporate and long-term investors in thin trading conditions.
“It’s getting fairly illiquid now so what flows do go through tend to be investors with multi-year horizons like sovereign wealth funds and they are always euro buyers,” Nomura’s Kendrick said.
The dollar rose 0.2 percent to 84.35 yen, close to Monday’s 20-month high of 84.48 yen. Traders cited an options barrier at 84.50 yen and stop loss buy orders above that level.
The euro rose to a high of $1.3256 on trading platform EBS, its strongest level since early May. It was last up 0.15 percent on the day at $1.3247, edging higher after data showed the German Ifo business climate index rose slightly more than expected in December.
Optimism for a deal to avert a looming U.S. fiscal crisis grew on Monday after President Barack Obama made a concession with his offer to limit tax increases to incomes exceeding $400,000 per household, a higher threshold than what the president had sought earlier.
If U.S. policymakers do reach a compromise before steep tax hikes and spending cuts kick in early next year, strategists said currencies that tend to gain on a better global growth outlook - like the euro and Australian dollar - should benefit.
Expectations of looser policy from the BOJ, which tend to weigh on the yen, have been bolstered by a landslide election victory for Japan’s Liberal Democratic Party (LDP) at the weekend. The LDP is committed to aggressive monetary easing.
Persistent yen-selling interest from non-Japanese players has helped to drag the yen lower, said Jesper Bargmann, Asia head of G11 spot FX for RBS in Singapore. He expected the dollar to stay supported ahead of BOJ’s policy decision on Thursday.
“I don’t think we’re going to break back down through 83.70 before the BOJ announcement tomorrow,” Bargmann said.
Fourteen of 19 economists polled by Reuters last week said they expected the BOJ to ease this week, most likely by increasing its 91 trillion yen ($1 trillion) asset buying and lending programme by up to 10 trillion yen.
Investors are also focused on whether the BOJ will raise its inflation target. Several sources familiar with the BOJ’s thinking have said the central bank will consider no later than January whether to adopt a 2 percent target.
In addition to speculation that the BOJ might ramp up monetary easing in coming months, a deterioration in Japan’s trade balance has also contributed to the recent bets against the yen.