* Dollar/yen retreats after hitting high of 90.25 yen * Investors position for aggressive action from BOJ * Risk of disappointment could lead to yen gains By Anooja Debnath LONDON, Jan 21 (Reuters) - The yen recovered from a 2-1/2 year low against the dollar on Monday with traders trimming large bets against the currency in case easing measures expected from a Bank of Japan meeting fall short of expectations. The yen is likely to stay firm until the BOJ's policy decision is known after the two-day meeting ends on Tuesday. The central bank, which is expected to double its inflation target and increase its asset purchase programme, said it would begin its meeting on Tuesday earlier than usual. Traders and analysts said if the BOJ met expectations then the dollar would lose a bit more ground, given its has made huge gains since October and investors like hedge funds would be keen to book profits. Short yen and long dollar positions were significantly large before the BOJ meeting. Financial markets are expecting a joint statement from the bank and the government to announce a 2 percent inflation, an increase in asset purchases with an open-ended commitment, and possibly other measures, traders said. The dollar rose to as high as 90.25 yen earlier on Monday, its highest since June 2010. It later slipped 0.7 percent on the day to 89.39 yen, as traders cut short positions given the BOJ has often fallen short of market expectations. "We see a bit of short covering going into the BOJ meeting with people being a little mindful that there could be some disappointment," Jeremy Stretch head of currency strategy at CIBC World Markets. "Investors are being mindful that the moves we have seen over the course of the last month or two are just worth locking in at least until we understand how the BOJ are really going to play in the future." Chartists cited support for the dollar near 89.10 yen, the low hit on Jan. 14, and said if it stayed above that investors would still see it as a good opportunity to buy dollars on dips. Since mid-November, the dollar has risen about 13 percent on the yen while the euro has risen about 20 percent against the Japanese currency. "From here we will probably see rallies sold into ... as the street reduces short yen positions into the BOJ meeting tomorrow," said Jeffrey Halley, FX trader at Saxo Capital Markets in Singapore. Against the yen, the euro fell 0.8 percent to 118.95 yen , off a 20-month peak of 120.73 hit last week, while the Australian dollar shed 0.5 percent to 94.19 yen, slipping from a four-year high of 95.02 set Friday. EURO FIRM The euro was down 0.1 percent on the day at $1.3320, having been capped by the $1.3400 level in the past week. The single currency showed a muted response after the victory of Germany's centre-left opposition in a regional vote in Lower Saxony on Sunday. Strategists said the euro was likely to remain firm over the next few sessions as concerns around the euro zone crisis continued to ease, unless sentiment data later this week surprised to the downside. Data on Friday showed currency speculators increased their bets against the U.S. dollar and went long on the euro, helped by European Central Bank chief Mario Draghi's comments that prospects in the euro zone were starting to improve. Speculators trimmed their bets against the yen in the week to Jan. 15, although they remained overwhelmingly negative on the currency. Traders said there was strong demand for options betting on further yen weakness, with one-month dollar/yen implied volatility - a measure of expected price movement - having risen to its highest since August 2011 on Friday. "We expect the door for further easing will likely be left open irrespective of the outcome of the BOJ policy meeting, either explicitly by the BOJ or implicitly through the government's plan to nominate doves to replace the governor and deputy governors," analysts at Barclays Capital wrote in a client note. "Expectations of an aggressive monetary policy stance under new BOJ leadership are likely to provide support for dollar/yen in coming weeks." Current BOJ Governor Masaaki Shirakawa's tenure ends in April and Japan's new government is keen to nominate a central bank chief who will be far more aggressive in beating deflation.