* Dollar supported by higher Treasury yields * Bank of Japan votes to keep monetary policy loose * Euro down, S&P downgrades European Union By Laurence Fletcher LONDON, Dec 20 (Reuters) - The dollar hit a five-year high versus the yen on Friday as markets focused on the divergence between U.S. and Japanese monetary policy, driving U.S. Treasury yields higher after Wednesday's Fed decision to start cutting bond-buying. The greenback also gained against the euro, which was held back by S&P's decision to cut the European Union's supranational long-term rating to AA-plus from AAA, citing rising tensions on budget negotiations. The dollar, which looks set to be backed by relatively higher interest rates next year if the Federal Reserve gradually calls a halt to bond-buying, rose to 104.60 yen on the EBS trading platform, its highest since October 2008, and was recently at 104.45 yen, up 0.2 percent. In contrast to the Fed, the Bank of Japan reaffirmed overnight it would keep monetary policy loose and dollar bulls are now targeting a level around 105.25 yen, a 61.8 percent retracement of the dollar's fall from its 2007 high of 124.14 yen to its 2011 low of 75.31 yen. "This is mainly dollar strength," said Ulrich Leuchtmann, head of currency research at Commerzbank in Frankfurt. "The yen has suffered most because of 'risk-on', due to (Fed chairman Ben) Bernanke's promise not to hike rates for the foreseeable future." The euro, which has surprised many analysts and hedge fund managers by moving higher against the dollar since the summer, was down 0.1 percent against the dollar at $1.3632. The single currency has been boosted by tightening monetary conditions in the euro zone as banks repay cheap borrowing to the European Central Bank. Next week banks will return 20.7 billion euros, the ECB said on Friday, which is above expectations and which will offer further support to the currency. MORE FROM BOJ TO COME Two-year U.S. yields rose from 0.34 percent to 0.3677 percent on Thursday, with the differential over Japanese two-year yields now at its highest level since early October. The Bank of Japan voted unanimously to maintain its pledge of increasing base money, or cash and deposits at the central bank, at an annual pace of 60 trillion yen ($576 billion) to 70 trillion yen. Bank of Japan Governor Haruhiko Kuroda said on Friday that the correction in the yen's "excessive" strength had been positive for Japan's economy. Nearly two-thirds of Japanese companies expect the BOJ to ease further in the first six months of 2014, as it tries to achieve 2 percent inflation within two years, a Reuters poll showed earlier this month. "No change (in BoJ policy) is likely until perhaps after the hike in the consumption tax in April," said Marshall Gittler, head of global FX strategy at IronFX Global. "After that, look for further easing to help the economy, which should weaken the yen further." The Australian dollar was trading above a 3-1/2-year low hit after the Fed revealed its stimulus reduction plans. The Aussie fell as far as $0.8820, its lowest since August 2010, and on Friday was last 0.1 percent down on the day at $0.8859.

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