FOREX-Yen hits 2-wk high as Japanese stimulus expectations dialled back

(updates prices)

* Bank of Japan expected to take easing steps on Friday

* Japanese fiscal stimulus may be less than thought

* Sterling drops after Weale U-turn

By Anirban Nag

LONDON, July 26 (Reuters) - The yen hit a two-week high against the euro and rose more than 1 percent against the dollar on Tuesday, as traders dialled back expectations of how much new stimulus authorities will inject into Japan's ailing economy.

Most economists surveyed by Reuters expect the Bank of Japan to expand its asset purchases and cut rates further below zero at its two-day meeting that ends on Friday.

Meanwhile the government is compiling a spending package that some sources have said could be worth up to 20 trillion yen. Direct fiscal stimulus may be much lower, with a Nikkei report on Tuesday citing a figure of around 6 trillion yen over the next few years. The total size of the package could be announced as soon as Aug. 2, Nikkei said.

Direct stimulus of 6 trillion yen would be double the amount initially planned but would fall short of market expectations, analysts said.

"There is some position unwinding going on with investors toning down expectations of how much fiscal stimulus will be provided," said Yujiro Goto, currency strategist at Nomura.

"We are also seeing not much pressure from the Japanese government on the BOJ to ease. All this is helping the yen."

The dollar slid 1.7 percent against the yen to 103.995 , its lowest since July 14 before recovering to trade at 104.42, still down 1.3 percent on the day. The euro fell to 114.465 yen, its lowest since July 12, before climbing to 114.96, still down 1.1 percent.

The yen has weakened in the past few weeks on growing expectations that Japanese authorities would provide both fiscal and monetary stimulus to kick-start inflation. Some have been hoping for helicopter money, whereby the central bank would underwrite government debt, though policymakers have denied this is being considered.

STERLING DROPS

Sterling shed 2 percent against the yen and hit a two-week low against the euro after Bank of England policymaker Martin Weale said he had dropped his opposition to policy easing and now favoured immediate stimulus. .

The pound also fell against the dollar to trade at $1.3125

"When the previously hawkish BoE MPC member Martin Weale turns dovish, market participants better listen," said Hans Redeker, head of currency strategy at Morgan Stanley (Xetra: 885836 - news) .

Meanwhile, the Federal Reserve is expected to stand pat on policy at its meeting that ends on Wednesday. Fed fund futures on Monday indicated that the market sees nearly no chance of a rate hike this week. But the chances of a December hike rose to 56 percent, up from 48 percent on Friday.

The dollar index, which tracks the currency against a basket of six major rivals, was down 0.25 percent to 97.047, off a peak of 97.569, its highest since March. (Additional reporting by Lisa Twaronite; editing by John Stonestreet)