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Media report BOJ could tweak yield cap

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10-yr JGB yields bust above cap; yen leaps, Nikkei sinks

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Dollar gains elsewhere on strong U.S. data, ECB shift

By Tom Westbrook

SYDNEY, July 28 (Reuters) - Asian stocks were off five-month highs and the yen extended a sharp rally on Friday with speculation that the Bank of Japan could take another small step toward dismantling its super-easy stimulus policies.

The BOJ sets policy later in the session. The Nikkei newspaper reported, without citing sources, that policymakers will discuss tweaking the yield control policy to allow 10-year government bond yields above a 0.5% cap in some circumstances.

The yield leapt to 0.505% in early trade.

The yen had earlier jumped about 0.5% on the report, gaining even as the dollar rose elsewhere after strong U.S. economic data and a toned down outlook from the European Central Bank.

The yen was holding about 0.5% higher at 138.83 per dollar in early trade, helped by Tokyo consumer prices rising slightly more than expected and as the risk of a policy surprise spooked short sellers.

"I wouldn't be running short into the BOJ," said Westpac strategist Imre Speizer.

"I think the idea is even a tiny tweak is a big deal for the BOJ. We'll probably get a reaction either way."

MSCI's broadest index of Asia-Pacific shares outside Japan fell 0.4%. Japan's Nikkei opened 1.4% lower though bank shares surged to an eight-year high on the prospect of rising interest income at lenders.

"If the BOJ adjusts its yield curve control program, financial markets will likely take it as the start of a policy tightening cycle regardless of the BOJ's rationale," said Commonwealth Bank of Australia strategist Kristina Clifton.

"Under such scenario, we consider dollar/yen ... can lose about two to four yen on the day."

A tweak would also cap what may prove a landmark week for central banks, with markets pricing a better-than-even chance that the Federal Reserve and ECB have made their final hikes of the cycle.

On Thursday, the ECB raised rates by 25 basis points to a 23-year high, as expected, but President Christine Lagarde sent the euro tumbling with talk of a pause in September.

"Do we have more ground to cover? At this point in time I wouldn't say so," Lagarde told reporters. The euro slid nearly 1% overnight and nursed losses at $1.0980 on Friday.

On Wednesday, the Fed had also hiked by 25 bps and Chair Jerome Powell cheered investors when he said the central bank's staff no longer forecast a recession.