By Kevin Plumberg HONG KONG (Reuters) - The U.S. dollar dropped to an 11-week low and government bonds rose on Wednesday after the Federal Reserve slashed rates, paving the way for Asian policymakers to take more aggressive steps to support growth. Stock markets in Japan and South Korea fell, with shares of car manufacturers under fire on faded hopes of an imminent U.S. auto industry bailout, overshadowing strength in sectors sensitive to interest rates. U.S. Treasuries slid after a sharp rally overnight, but Japanese government bonds climbed, pushing down the 2-year yield to the lowest since February 2006, on growing speculation the Bank of Japan would cut the overnight cash rate from its current low level of 0.3 percent as early as Friday. Government bonds rallied after the Fed also said it would use unconventional means to revive the U.S. economy from a deep recession, including buying long-dated Treasuries, as other central banks were expected to slash their benchmark rates, ushering in an unprecedented era of cheap money. "This opens the door for more rate cuts in Asia. Everyone is now looking at the Bank of Japan, which may feel compelled to cut rates for some symbolic gesture," said David Cohen, director of Asian economic forecasting with Action Economics in Singapore. "The Fed has emphasized the further deterioration of their economy. A similar situation holds in Asia, so central banks will have some motivation to cut rates further." Prospects for lower borrowing costs helped to lift the MSCI index of stocks in the Asia-Pacific region outside Japan .MIAPJ0000PUS to the highest since November 11, up 2.3 percent on the day and extending its gains this month to 10.2 percent. However, Japan's Nikkei share average .N225 shed early gains and slipped 0.5 percent, led by a 7 percent drop in Honda Motor Co (7267.T: Quote, Profile, Research, Stock Buzz). Strength in the yen also walloped exporter stocks already facing weak global demand. Honda, Japan's No.2 automaker, was poised to issue its third profit warning in five months, citing huge currency losses and tanking car sales. Automakers everywhere are reeling from a sharp downturn in sales due to a global recession and tight credit, and are under pressure to delay investments and expansion plans. Hong Kong's Hang Seng index .HSI climbed 0.9 percent, boosted by property-related stocks such as Sun Hung Kai Properties (0016.HK: Quote, Profile, Research, Stock Buzz) on hopes for lower borrowing costs. In an all-out battle to protect the U.S. economy from profit-evaporating deflation, the Fed explicitly said it would take steps to make sure benchmark rates remain low for some time and to keep its balance sheet loaded with debt. DOLLAR RALLY LOOKS MATURE The prospect of effectively littering the financial system with dollars kept the U.S. currency struggling. The rally it enjoyed earlier this month on the back of U.S. investor capital flows back home has clearly faded. "You are starting to move away from dollar-positive signals and dollar-bullish signals we've had over recent months," said Dwyfor Evans, currency strategist with State Street Global Markets in Hong Kong. "People are getting a little concerned with the whole idea of quantitative easing. To the extent that means simply throwing more dollars on to the market, then that implies a weakness in the currency," he said.

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