The Bank of Japan will hold an emergency meeting on Monday to ease monetary policy in the face of strong government pressure as the yen's strength threatens a fragile economic recovery.
The most likely option is to expand a cheap fixed-rate loan programme for banks, sources familiar with the BOJ's thinking said, although any such move is already widely expected and unlikely to weaken the yen for long.
Sources had told Reuters that the BOJ was expected to hold an extra meeting early in the week to loosen policy as the strong yen threatens Japan's fragile economic recovery.
The early return by BOJ Governor Masaaki Shirakawa from his trip to the United States made an emergency BOJ meeting on Monday almost a certainty as of Sunday.
The central bank's nine-member board will meet from 9:00 a.m. (1:00 a.m. BST). Governor Shirakawa will hold a news conference at 2:30 p.m. (06:30 a.m. BST), the BOJ said.
Japanese policymakers have tried to talk down the yen and signaled the chance of intervening in the market after the Japanese currency hit a fresh 15-year high against the dollar last week.
The government has also heightened pressure on the BOJ to do its part to support growth and help curb rises in the yen, which hurt exports and may delay Japan's exit from deflation.
Prime Minister Naoto Kan said last week that he wanted to meet Shirakawa as soon as he returns from his trip to the United States, and request a flexible monetary policy response to the strong yen.
Shirakawa will meet with Kan on Monday to discuss economic and market developments, public broadcaster NHK said.
The BOJ likely aimed to hold the emergency meeting before the two meet to avoid giving markets the impression it yielded to government pressure, analysts said.
LINING UP OPTIONS
Japan will likely need to intervene alone if it were to step in to curb yen gains, as its Group of Seven counterparts, happy with the benefits to exports from their weak currencies, are in no mood for coordinated intervention.
Solo currency intervention, however, will not have much effect in weakening the yen unless joined by aggressive monetary easing by the BOJ, traders say.
The BOJ has been considering easing policy and lining up its options, but had wanted to wait until its next regular rate review on September 6-7 for clearer evidence of the harm the yen's rise was inflicting on business sentiment.
There is a slim possibility the BOJ will opt for aggressive measures, such as increasing government bond purchases or cutting its overnight rate call target, as some government officials are already complaining that minor tweaks to the fund supply scheme would not be enough.
But the BOJ will likely save such bold steps for when Japan's economy slows further later this year on weakening export growth.
The BOJ set up the cheap funding scheme, which offers up to 20 trillion yen ($234.3 billion) in three-month loans at 0.1 percent, in December, at an emergency meeting held a day before Shirakawa met with then Prime Minister Yukio Hatoyama. That failed to boost bank lending but helped to push the yen further away from a November high.
The central bank is expected to either boost the size of money on offer to 30 trillion yen, or extend the duration of fixed-rate loans to six months.
Such a step could push down interbank lending rates and indirectly weaken the yen, although the impact would likely be limited and short-lived with money market rates already very low.
In a sign markets are awash with more funds than banks can swallow, the fund supply operation now draws bids nearly five times the amount offered at each operation, down from about seven times in the previous month.
Expanding the fund supply tool would therefore be more of a token gesture to show that the central bank was doing what it could to support the economy.
With short-term rates already very low, investors are pushing down the longer end of the yield curve on expectations of further monetary easing, causing it to flatten.
While the yield curve steepened on Friday as banks sold superlong bonds to take profit, the curve is still at its flattest in months, partly because of deep skepticism that Tokyo has any tools left to fight deflation.
The BOJ last eased monetary policy in March, when it doubled the size of the fixed-rate fund supply tool to 20 trillion yen.
(Editing by Edmund Klamann)