* Elevated U.S. bond yields help dollar
* Gap between 2-yr US/Japan bond yield at 1-1/2 yr high
* Euro hits 1-month high versus yen
By Anirban Nag
LONDON, Aug 23 (Reuters) - The dollar hit a three-week high against the yen on Friday and climbed versus a basket of currencies, helped by this week's rise in U.S. bond yields.
The dollar index has a strong correlation with U.S. Treasury yields which have spiked on rising expectations that the Federal Reserve will slow its bond-buying programme as early as next month.
Higher yields make holding dollar-denominated assets attractive with the gap between two-year U.S. Treasury yields and their Japanese counterparts at its highest since March 2012. That will draw more Japanese investors into U.S. Treasuries and help the dollar, analysts said.
The dollar rose 0.3 percent to 99 yen, having hit a three-week high of 99.14 yen on trading platform EBS. Traders cited decent demand from U.S. funds and Japanese buyers with stop-loss buy orders cited above 99.15 yen.
"We have seen a bit more interest in buying dollars after the Fed minutes earlier this week," said Chris Walker, currency strategist at Barclays. "We are forecasting the 10-year U.S. yields to rise to 3.75 percent by the end of the third quarter of 2014. That should be helpful for the dollar."
Treasury yields got a boost this week after minutes of the Fed's July meeting released on Wednesday did little to change market expectations of the Fed's tapering timetable.
The U.S. 10-year Treasury yield last stood near 2.892 percent, having set a two-year high of 2.936 percent on Thursday. With the Bank of Japan set to keep policy ultra-loose after embarking on a massive stimulus programme in April, the gap between 10-year U.S. bond yields and Japanese government bonds was near its highest since April 2011.
Investors were also keeping an eye on moves in Japanese shares, since the yen has moved in opposing directions to the benchmark Nikkei share average this year.
The Nikkei rose 2.2 percent on Friday after business surveys on Thursday suggested the world economy was on the mend, with U.S. and Chinese manufacturing activity at multi-month highs and business activity in the euro zone picking up.
The euro touched a one-month high against the yen at 132.34 yen and last stood near 132.05 yen, up 0.15 percent. Against the dollar, the euro eased 0.1 percent to $1.3341 , but remained above Thursday's intraday low near $1.3299.
The euro had set a six-month high of $1.3453 earlier this week, supported by a recent improvement in euro zone economic data. A second reading of German gross domestic product data confirmed that Europe's biggest economy grew by 0.7 percent in the second quarter, helped by domestic demand..
The recent pick up has pushed euro zone money market rates higher and if sustained is likely to challenge the effectiveness of the European Central Bank's pledge to keep rates low until a full-fledged recovery is in place.
"The euro seems irrepressible at the moment, but we think the Fed normalisation story will win out for the dollar," said Chris Turner, head of currency strategy at ING.
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