FOREX-Dollar extends rally after Fed, yen held back by BoJ
* Dollar supported by higher Treasury yields
* Bank of Japan votes to keep monetary policy loose
* Euro down, S&P downgrades European Union
LONDON, Dec 20 (Reuters) - The dollar hit a five-year high versus the yen on Friday as the fallout of Wednesday's decision by the Federal Reserve to begin cutting bond-buying seeped into markets, driving U.S. Treasury yields higher.
The greenback also gained against the euro, which was held back by S&P's decision to cut the European Union's supranational long-term rating to AA-plus from AAA, citing rising tensions on budget negotiations.
The dollar, looking set to be backed by relatively higher interest rates next year if the Fed gradually calls a halt to bond-buying, rose to 104.60 yen on the EBS trading platform, its highest since October 2008, and was recently at 104.48 yen.
In contrast to the Fed, the Bank of Japan reaffirmed overnight it would keep monetary policy loose and dollar bulls are now targeting a level around 105.25 yen, a 61.8 percent retracement of the dollar's fall from its 2007 high of 124.14 yen to its 2011 low of 75.31 yen.
"This is mainly dollar strength," said Ulrich Leuchtmann, head of currency research at Commerzbank in Frankfurt.
"The yen has suffered most because of 'risk-on', due to (Fed chairman) Bernanke's promise not to hike rates for the foreseeable future."
The euro, which has surprised many analysts and hedge fund managers by moving higher against the dollar since the summer, was down 0.2 percent against the dollar at $1.3632.
That looks substantially the result of tightening monetary conditions in the euro zone as banks repay cheap borrowing to the European Central Bank. ING analyst Chris Turner said the focus on Friday will be on the size of the last repayment of the year, with 12 billion euros expected to be paid back after last week's 22.6 billion euros.
MORE FROM BOJ TO COME
Two-year U.S. yields rose from 0.34 percent to 0.3677 percent on Thursday, with the differential over Japanese two-year yields now at its highest level since early October.
The Bank of Japan voted unanimously to maintain its pledge of increasing base money, or cash and deposits at the central bank, at an annual pace of 60 trillion yen ($576 billion) to 70 trillion yen.
Bank of Japan Governor Haruhiko Kuroda said on Friday that the correction in the yen's "excessive" strength had been positive for Japan's economy.
Nearly two-thirds of Japanese companies expect the BOJ to ease further in the first six months of 2014, as it tries to achieve 2 percent inflation within two years, a Reuters poll showed earlier this month.
Citi's Japan economics team expects the BOJ to opt for additional quantitative easing measures in June or July next year. They saw the dollar reaching an upside target of 108 yen around the same time.
The Australian dollar rebounded from a 3-1/2-year low hit after the Fed revealed its stimulus reduction plans.
The Aussie fell as far as $0.8820, its lowest since August 2010, but was last slightly higher on the day at $0.8868.