* USD defensive as risk-taking returns on stocks, commodities
* Cross/yen gains but traders debate Japan's next move
By Charlotte Cooper
TOKYO, Dec 2 (Reuters) - The dollar was on the defensive on Wednesday and the yen was on the back foot against higher-yielding currencies as rising stocks and commodity markets encouraged a pick-up in risk-taking.
Traders and analysts in Japan were still chewing over steps by the central bank the previous day to attack deflationary pressures, which left many disappointed, and were keen to hear the outcome of a meeting between Prime Minister Yukio Hatoyama and Bank of Japan Governor Masaaki Shirakawa due late in the day.
Many in the market doubted the Bank of Japan's new 0.1 percent funding operation, aimed at keeping short-term rates down, could slow a fall in the dollar for long and were looking for hints on what Japanese authorities might do next.
The greenback hit a 14-year low of 84.82 yen last week as concerns about debt problems in Dubai saw investors unwinding risk trades funded by the yen, which pushed the Japanese currency higher.
Traders said Japanese exporters, nervous they would not get better exchange rates, were ready to sell into dollar and euro rallies against the yen, whic could create headwinds to moves up.
"Dollar/yen will be very heavy on top but in the meantime the receding concern on the Dubai problem has reduced demand for U.S. Treasuries and flight to quality," said Masafumi Yamamoto, chief FX strategist Japan at Barclays Capital.
The dollar stood at 86.93 yen, up 0.3 percent on the day but faltering at the 87.00 mark.
The euro rose 0.3 percent to 131.21 yen and firmed slightly to $1.5094 after gaining 1 percent and 0.5 percent respectively the previous day. It was within sight of a recent 16-month high of $1.5145 set on trading platform EBS, with strong trendline support seen at $1.4900 and then at $1.4860.
The dollar index, a measure of its strength against a basket of six currencies, was steady at 74.400, not far above last week's 16-month low of 74.17.
SOME IMPACT ON BORROWING COSTS
The BOJ said after an emergency meeting on Tuesday it would provide 10 trillion yen ($115 billion) in three-month funds at a fixed rate of 0.1 percent, relieving government pressure to act against deflation and avert another recession. See.
Tuesday's decision was seen as a way to avoid a return to a narrow form of quantitative easing, under which the BOJ slashed rates to zero and flooded markets with cash in 2001-06.
Yen borrowing costs did fall, with the three-month interbank rate reaching its lowest level since May 2006 on Tuesday to fix at 0.29375 percent.
But it remained above the equivalent dollar rate, which was fixed at 0.25531 percent, and traders were sceptical this would support the dollar for long, with some readying to go long yen once the dollar rises above 87.00 yen.
A BOJ official said the central bank would not rule out any policy options and it must be aware of the risk to inflation expectations if the yen's rise was seen to harm the economy.
The government is expected to prepare an economic stimulus package this week to shore up a fragile economy.
"The focus now shifts to the government and the size of the supplementary budget and whether there will be any action by the Ministry of Finance in the foreign exchange market," Barclays Capital's Yamamoto said.
Traders say unilateral action by Japan to curb the yen's rise would be tricky without some form of consent from other world economic powers, and many doubt the authorities would want to step in before the dollar fell towards 80 yen, or even neared its record low of 79.75.
"Until then they just want to talk the dollar/yen up a bit," one trader at a Japanese bank said.
Markets will be watching U.S. data later, ahead of monthly jobs numbers due on Friday. A November employment report by Automatic Data Processing at 1315 GMT is expected to show 155,000 jobs lost in the month after 203,000 lost in October.
With worries about Dubai's debt problems receding, investors have turned their focus to optimistic data out of China and Europe..
Commodities and stock markets drew support from that, although shares in Japan eased as the BOJ steps fell short of expectations, with demand underpinned for higher-yielding currencies like the Australian and New Zealand dollars.
The Aussie rose 0.3 percent to $0.9278, having jumped more than 1 percent on Tuesday. Part of the rise was due to the third straight monthly hike in the cash rate by the Reserve Bank of Australia and higher gold prices.
Against the yen, it gained 0.5 percent to 80.62 yen. (Additional reporting by Satomi Noguchi in Tokyo and Anirban Nag in Sydney; Editing by Chris Gallagher) ((Email: charlotte.cooper@thomsonreuters.com; +81 3 6441 1870; Reuters Messaging: charlotte.cooper.reuters.com@reuters.net)) ((If you have a query or comment on this story, send an email to news.feedback.asia@thomsonreuters.com))