LONDON (Reuters) - The yen fell sharply on Wednesday after Japanese Prime Minister Yoshihiko Noda said he was open to dissolving the lower house of parliament later this week and to hold elections next month. The prospect of an early election is regarded as negative for the currency, as the most likely victor would be the main opposition Liberal Democratic Party (LDP). An LDP-led government is expected to put more pressure on the Bank of Japan (BOJ) to further ease monetary policy and that would weigh on the yen. The yen fell against the dollar and the euro as hedge funds and long-term investors such as reserve managers sold. The dollar rose 0.7 percent to 79.90 yen and the euro climbed 0.9 percent on the day to 101.75 yen. Noda, whose ruling Democratic Party could be headed for a drubbing according to a media poll, told parliament he would be willing to dissolve parliament on November 16 and hold elections in December if the opposition agreed to pass reforms to the electoral system. "Ultimately, both parties will put pressure on the Bank of Japan to ease policy," said Neil Mellor, currency strategist at Bank of New York Mellon. "Whether the opposition LDP will put more pressure is something investors will be looking out for." Shinzo Abe, the opposition LDP's leader and possible prime minister, is a vocal critic of the BOJ, and has called for setting a 3 percent inflation target, higher than the central bank's 1 percent goal. He has also been pressuring the bank to take bolder action to fight deflation. "The financial markets can now begin to price more confidently the risk of more overt political pressure on the BOJ to rid Japan of deflation," Derek Halpenny, European head of global market research at Bank of Tokyo Mitsubishi, wrote in a note. "This is a clear yen-negative story for 2013. The spike today also is indicative of a short-term market that has increasing appetite for selling the yen." Investors are also worried the LDP may be less committed to fiscal belt-tightening measures such as planned tax hikes than Noda's party. "The yen could weaken for both of those reasons," said Masafumi Yamamoto, chief FX strategist at Barclays in Tokyo. FED AND THE DOLLAR The yen aside, the dollar eased against most major currencies including the euro and the Australian dollar on growing signs that the Federal Reserve is likely to adopt an ultra-loose monetary stance in coming months. Influential Fed Reserve Vice Chair Janet Yellen said on Tuesday that U.S. interest rates may need to stay near zero until early 2016 to forcefully lift employment. The minutes from the latest Federal Open Market Committee meeting will be released later on Wednesday and is likely to confirm an easy policy bias for sometime to come, a factor which could limit the dollar's recent gains. The dollar index <.DXY> was slightly lower on the day at 81.045, having hit a two-month high of 81.241 on Tuesday. The euro was up 0.2 percent at $1.2734, helped mainly by its gains against the yen. The single currency has rebounded from a two-month low of $1.26610 struck on Tuesday on expectations that debt-laden Greece could receive aid worth roughly 44 billion euros at one go. But that cannot happen until international lenders reach a broader agreement on the sustainability of Greece's debt, all of which is likely to check the euro's gains.

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