By Rae Wee

SINGAPORE (Reuters) - The dollar firmed near a six-month peak against the yen on Friday on the back of rising U.S. Treasury yields, as optimism over debt ceiling talks in Washington raised expectations of higher-for-longer interest rates.

President Joe Biden and top U.S. congressional Republican Kevin McCarthy earlier this week underscored their determination to strike a deal soon to raise the government's $31.4 trillion debt ceiling, with hopes of finalising a deal after Biden returns from the Group of Seven meeting in Japan on Sunday.

The news helped calm fears of an unprecedented and economically catastrophic American debt default, leading markets to revise their expectations of where U.S. interest rates could go.

At the same time, data pointing to a still-tight labour market, with the number of Americans filing new claims for unemployment benefits falling more than expected last week, also reinforced expectations that the Federal Reserve could deliver another rate hike next month in a bid to tame inflation.

Two Fed policymakers also said on Thursday that U.S. inflation does not look like it is cooling fast enough to allow the Fed to pause its interest-rate hike campaign.

The dollar stayed elevated in early Asia trade on Friday and last bought 138.40 yen, having risen to a near six-month high of 138.75 yen in the previous session.

The greenback was eyeing a weekly gain of nearly 2% against the Japanese currency, its largest since February.

Similarly, the U.S. dollar index was last at 103.46, flirting with Thursday's two-month high of 103.63, and was headed for a second straight weekly gain of more than 0.7%.

"Optimism about the debt ceiling (talks) has contributed to a repricing for the Fed ... the fact that (a deal) would remove a big weight on the economy, effectively," said Ray Attrill, head of FX strategy at National Australia Bank (OTC:NABZY) (NAB).

"It does remove one obstacle to the Fed continuing to raise rates."

Money markets are now pricing in a 39% chance that the Fed could raise rates by another 25 basis points next month, compared with just about a 10% chance a week ago, according to the CME FedWatch tool.

Traders have also pared expectations on the scale of rate cuts expected later this year, with rates seen just above 4.6% by December.

U.S. Treasury yields have climbed on the back of the hawkish Fed repricing and amid a pick up in risk sentiment. Yields rise when bond prices fall.

The two-year Treasury yield, which typically moves in step with interest rate expectations, last stood at 4.2581%, edging away from a low of 3.964% at the start of the week.

The benchmark 10-year yield was last at 3.6476%, having risen nearly 20 bps this week.

In other currencies, the euro rose 0.06% to $1.0777, but languished near the previous session's close to two-month low of $1.07625.

Sterling gained 0.05% to $1.2415, having fallen about 0.6% on Thursday.

The Aussie edged 0.17% higher to $0.6633, having slid on Thursday against a stronger dollar and on data showing that Australia's employment unexpectedly dipped in April.

In Asia, Japan's core consumer prices rose 3.4% in April from a year earlier as price hikes broadened, data showed on Friday, casting doubt on the central bank's view inflation will slow back below its 2% target later this year as cost pressures dissipate.

"I do think that the numbers do mean that the June and July meetings are live for a possible YCC tweak," said NAB's Attrill, referring to the Bank of Japan's controversial yield curve control policy.