* Euro hits three-week high, Aussie back above parity vs USD
* But S&P warns on Belgian ratings, pulling euro off highs
* FOMC expected to stick with QE mantra
(Adds quote, detail)
By Neal Armstrong
LONDON, Dec 14 (Reuters) - The euro hit three-week highs versus the dollar and yen in thin trade on Tuesday, as investors took the view that a recent rise in front-end U.S. yields had gone too far, prompting a squeeze of euro shorts.
The Australian dollar jumped to a one-month high above parity with the U.S. dollar, helped by a rise in prices of gold and other commodities such as copper and by broad dollar weakness.
Traders said investors were trimming positions ahead of a U.S. Federal Reserve policy meeting later on Tuesday.
The dollar's decline this week has coincided with a pullback in U.S. Treasury yields and a Moody's warning it could move a step closer to cutting the U.S. triple-A credit rating if a tax and unemployment benefit package becomes law. [ID:nN13105751]
"We are still seeing the fallout from the potential extension of a U.S. stimulus package, which has switched the near-term focus for the dollar from a pro-growth story to worries about fiscal stability," said Lee Hardman, currency analyst at BTM-UFJ.
The euro edged off highs, however, after the S&P rating agency said Belgium's sovereign debt could be downgraded within six months, reminding investors of the risk of contagion from the euro zone crisis. [ID:nWEA7396]
The euro
The euro also hit a three-week high at 112.22 yen
By 1220 GMT it had edged back to $1.3465 and to 111.80 yen.
Traders reported euro/dollar stop-loss orders lurking at and above $1.3500, adding the rally looked to be driven by speculators in a thin year-end market.
"The recent rise in front-end U.S. yields looks overdone as core inflation isn't going to pick up quickly," said Gavin Friend, currency strategist at nabCapital.
"Also euro zone bond spreads seem to have stabilised on the back of the recent ECB buying which has helped the euro.
The European Central Bank stepped up its purchases of government bonds last week, although the amount bought was still well below levels reached last spring.
The dollar fell broadly, hitting a three-week low versus a
currency basket at 78.819 <.DXY>. It slipped 0.5 percent to
82.97 yen
U.S. YIELDS FALL BEFORE FOMC
Buyers for U.S. bonds emerged after benchmark Treasury
yields surged to six-month highs on Monday. This helped knock
the 10-year yield down to 3.285 percent from 3.39 percent
U.S. policymakers were expected to reaffirm the Fed's quantitative easing policy while acknowledging some recent better economic data. [ID:nFEDAHEAD]
"The Fed will continue ploughing on with its QE stance. It won't divert from its intention to buy $600 billion in government debt until next spring at least," Friend said.
The Australian dollar rose to a one-month high of $1.0017
against the U.S. dollar