* Dollar vulnerable before Fed decision
* Hits 3-month low versus higher-yielding Aussie dollar
* Many expect Fed to announce bond buying of $45 bln a month
* But dollar at 8-month peak versus yen on BOJ expectations
By Jessica Mortimer
LONDON, Dec 12 The dollar dropped to a three-month low against the higher-yielding Australian dollar on expectations of further monetary stimulus from the U.S. Federal Reserve later on Wednesday.
But it hit an eight-month high against the yen on bets the Bank of Japan will implement more aggressive monetary easing after a likely victory of the Liberal Democratic Party in an election on Sunday.
The Fed is expected to announce a fresh round of Treasury bond purchases later on Wednesday, with many economists forecasting it will opt for monthly purchases of $45 billion.
However, analysts said there was a risk policymakers may decide to buy more than that, which would put the dollar under broad selling pressure.
"People are selling the dollar on the possibility that the Fed could do more easing than the market is expecting," said Niels Christensen, currency strategist at Nordea in Copenhagen.
"If it is a neutral decision they could buy it back on the fact. But if they do more, say above $50 billion, then the dollar would be on the defensive."
Further dollar falls could see the euro test last week's high of $1.3127, he said.
The euro was steady at $1.3002, well above a low of $1.2876 reached last week, holding gains made after surprising strength in German economic sentiment data on Tuesday.
Traders said the euro could extend gains if it rises above reported stop loss buy orders around $1.3015-20.
"Although the view that the Fed will shift to outright Treasury purchases is now very widely shared by market participants, we do not believe it has been fully reflected into markets or in positioning," said Vassili Serebriakov, a strategist at BNP Paribas.
A fresh round of outright bond purchases is expected to replace the Fed's expiring "Operation Twist" programme.
But the prospect of more monetary easing in Japan continued to hurt the yen, with the dollar rising 0.55 percent to hit an eight-month high of 82.94 yen, just shy of reported options barriers at 83.00 yen.
"A lot of investors are looking for a break of 83.00 yen ahead of the Japanese elections ... In the current environment where investors are struggling to find trends in currency markets people are keen to jump on the bandwagon with dollar/yen," Nordea's Christensen said.
The euro was up 0.4 percent at 107.76 yen, near last week's 7-1/2 month peak of 107.96 yen.
HUNGRY FOR YIELDS
The spectre of further easing in the United States is putting renewed focus on higher-yielding currencies as the world's four most liquid currencies -- the dollar, the euro, the yen and the pound -- all have near zero interest rates now.
The higher-yielding Australian dollar rose as high as $1.0542, its strongest since mid-September, stopping just shy of a reported options barrier at $1.0550 and near-term resistance around the Sept. 17 high of $1.0564.
"The Aussie remains one of a few currencies with yields therefore investors have no choice but to buy," said a Tokyo-based trader at a European bank.
The U.S. dollar also fell to an eight-week low against the Canadian dollar of C$0.9856, while the New Zealand dollar hit a nine-month high of $0.8407.
The dollar index stood at 80.068, little changed on the day but down around 0.5 percent so far this week.
For now, it is holding above a 61.8 percent retracement of its rally last week at 80.00, but a fall below that level could open the way for a test of six-week low of 79.568 hit last week.
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