Japanese stocks fell on Friday after a rise to a seven-month high earlier in the day prompted profit taking, although they outperformed the rest of Asia this week, while U.S. Treasuries steadied on the view yields had risen too high, too quickly.

European shares rose for the fifth straight session, with the FTSEurofirst 300 <.FTEU3> up 0.2 percent and London's FTSE 100 <.FTSE> 0.3 percent firmer. U.S. stock index futures were up 0.2 percent.

With 2010 almost over, investors were reluctant to throw much money into any single trade now that a big selloff in Treasuries had died down and opted instead to take profits on small positions in thin trading volumes.

Whether China would raise interest rates this year, perhaps even this weekend, was on investor radar screens as they assess risk taking, especially after a state-run newspaper said inflation may have hit 5.1 percent in November.

Tighter policies in China and other emerging markets though have already been factored into economic and market forecasts for 2011, a year in which some strategists favor riskier assets such as stocks, commodities and credit, but not government bonds.

The environment looks quite favorable for equities now, but as we proceed through 2011 investors need to be alert to a change, Larry Kantor, head of research at Barclays Capital, said in a statement.

Overstretched valuations may provide that signal, as might central banks in emerging market countries as they pull back from extremely supportive policies over the course of 2011.

Japan's Nikkei share average finished 0.7 percent lower <.N225> after briefly touching its highest level since May 14, with investors concerned for a second day that share prices have been pushed up too quickly without any fundamental news to support the move.

On top of profit-taking and overheating of the market, some foreign investors are unloading positions and hedging ahead of the Christmas break, said Hiroaki Kuramochi, chief equity marketing officer at Tokai Tokyo Securities in Tokyo.

In the MSCI Japan index, the financials and materials sectors were the top performing sectors in the week, returning 2.7 percent and 2.4 percent, respectively.

The broader TOPIX index was up 1 percent <.TOPX> this week, exceeding the 0.2 percent fall of the MSCI index of Asia Pacific stocks outside of Japan <.MIAPJ0000PUS>.

The MSCI index fell 0.3 percent on Friday, with the biggest losses in the consumer discretionary sector, one of the top performing segments of the market this year.

SMALL SIGNS OF TRACTION

The U.S. Treasury market cooled after global investors sold mid to longer-maturity bonds earlier in the week on news the White House proposed a payroll tax holiday that some analysts and fund managers reckon could boost growth next year as much as a full percentage point.

The March 10-year U.S. Treasury future was up around 9/32, while the cash 10-year note yield was down 2 basis points on the day at 3.19 percent.

The yield has jumped 40 basis points so far in December, putting it on track for the biggest monthly increase since December 2009 when yields rose 64 basis points.

Pacific Investment Management Co, which runs the world's biggest bond fund, has revised its U.S. growth forecast for next year in light of the tax-cut compromise.

PIMCO sees the economy growing 3 percent to 3.5 percent in the fourth quarter of 2011 from the same period of this year. That compared with its previous estimate for 2 percent to 2.5 percent growth.

We have to recognize the small signs of traction in the economy, said Bernie Ward, head of non-yen sales and trading at RBS in Tokyo.

But Ward said that some investors, such as Asia-based portfolio and reserve managers, had been spooked by this week's volatility and may sit on the sidelines through the end of the year.

Real money is not yet ready to buy until we see some stability, he said.

The euro edged up 0.3 percent to $1.3270 with dealers comfortable keeping the currency tight to a downward trend line despite overnight news that Fitch Ratings downgraded Ireland's sovereign debt rating.

The euro reacted well to the Fitch news on Ireland and that really tells you that maybe this story is too well known and traders don't really want to sell it, said Robert Rennie, chief currency strategist at Westpac Bank in Sydney.

The euro was still in a down trend after hitting a 9-month high in early November and down 7.5 percent so far this year. However, for all the worries over the euro zone fiscal crisis, the currency is expected to fall only roughly two cents in 12 months to $1.3050, a Reuters poll of analysts showed.

(Additional reporting by Ian Chua in SYDNEY, Antoni Slodkowski in TOKYO and Eric Burroughs in HONG KONG)

Japan Fall