* Dollar holds above 90 yen as short positions trimmed
* Sterling slammed on report rates to stay low
* Focus on U.S. third-quarter earnings
* Holiday in U.S., Tokyo keeps activity thin
By Tamawa Desai
LONDON, Oct 12 (Reuters) - The dollar hit a two-week high against the yen on Monday with traders continuing to cover short positions as they debated how long U.S. interest rates will stay low.
The dollar had been under heavy selling pressure on the prospect that U.S. interest rates could remain low for some time. It hit its weakest level in eight months against the yen last week and a 14-month low against a basket of six currencies.
St Louis Federal Reserve President James Bullard, added to the debate on Sunday, saying medium-term inflation risks in the U.S. economy could be higher than thought.
This prospect, which could lead to monetary tightening, follows Australia's surprise interest rate hike last week and remarks by U.S. Fed Chairman Ben Bernanke on Thursday that policy could be tightened as a recovery takes hold.
His comments led to a sell-off in Treasuries, with 10-year U.S. government bond yields rising to two-week highs. Fed fund futures moved to price in a funds rate of around 0.3 percent in the March contract, up from near zero.
"Higher U.S. bond yields will provide a degree of support for the dollar, though the risks remain skewed toward the downside," said Lee Hardman, currency strategist at Bank of Tokyo-Mitsubishi UFJ.
At 0738 GMT, the dollar rose 0.5 percent from late Friday's levels to 90.23 yen after rising to 90.46, its strongest level since the start of the month and pushing up from the eight-month low of 88.01.
Dealers said there was talk of dollar stop-loss buy orders above 90.50-55 yen, with support for the U.S. currency down around 89.20.
Latest data on the Tokyo Financial Exchange showed net dollar/yen long positions exploded last week, tripling between Monday and Thursday, analysts at RBC Capital Markets said.
Sterling fell broadly, hitting a near six-month low against a basket of currencies after a report said British interest rates would stay at current rock-bottom levels for some time.
The Centre for Economics and Business Research (CEBR) said on Monday British interest rates would stay at 0.5 percent until 2011 and not rise to 2 percent until 2014.
The consultancy said in a report on the outlook for the UK economy that the pound could fall to $1.40 and possibly below parity with the euro as UK rates remained low, and the government raised taxes and cuts spending to reduce its budget deficit.
Activity was light with Tokyo markets shut for a one-day holiday and a federal holiday in the United States.
Going forward, traders will focus on financial earnings, with results from JP Morgan Chase and Goldman Sachs slated later in the week.
U.S. economic data this week includes September retail sales and consumer prices as well as industrial and manufacturing numbers.
The dollar index, a measure of the greenback against six major currencies, edged up to 76.630 after closing at 76.431 on Friday. It had hit a 14-month low of 75.767 last week.
The euro slid 0.2 percent to $1.4691, having lost 0.5 percent on Friday, but advanced 0.5 percent to 132.89 yen.
The Australian dollar gained to a two-month high of 81.49 yen but retreated from last month's 14-month peak of $0.9092 to stand at $0.8992.
(Additional reporting by Charlotte Cooper in Tokyo, editing by Nigel Stephenson)