The Bank of Japan began an emergency meeting on Monday to ease monetary policy, bowing to strong government pressure to try to curb a rise in the yen that is threatening a fragile economic recovery.
But analysts questioned whether the central bank would take steps bold enough to stem a rise in the Japanese currency that hurts exports and may delay Japan's exit from deflation.
The most likely scenario is that the BOJ will 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.
What won't make a difference is incremental policy shifts along the same lines that we've had before, said Richard Jerram, chief economist at Macquarie Securities (Japan) Limited.
Although Japanese nominal interest rates are at rock bottom, deflation has boosted real rates, deterring investment and driving up the yen as overseas investors seek real yields that are higher than those in other major economies.
It is also obvious that this is clearly a political move. The yen is where it was when the BOJ had their policy meeting in August so you can't say this is because the yen is strong, Jerram said.
Prime Minister Naoto Kan, keen to look proactive on the economy as he faces a challenge from powerbroker Ichiro Ozawa in a September 14 party leadership vote that could split the ruling party, was to meet BOJ Governor Masaaki Shirakawa after the policy board meeting, Jiji news agency reported.
Cabinet ministers are due to decide the basic thrust of additional measures to help the slowing economy at a meeting in later on Monday, Kyodo news agency said, but Japan's huge public debt, now twice the size of the economy, constrains his options.
The yen slipped broadly after the BOJ said it would hold the emergency meeting, with the dollar rising to the day's high of 85.75 yen on trading platform EBS, up from around 85.35 yen before the news reached the market. The dollar last stood at 85.7 yen, up about 0.6 percent from late trading on Friday.
The Nikkei stock average <.N225> jumped 2.6 percent and the benchmark 10-year Japanese government bond yield jumped more than 10 basis points.
Japanese policymakers have tried to talk down the yen, signalling the possibility of intervening in the market after the Japanese currency hit a fresh 15-year high of 83.58 yen against the dollar last week.
The government has also heightened pressure on the BOJ to do its part. Kan said last week that he wanted to meet Shirakawa as soon as he returned from his trip to the United States, and request a flexible monetary policy response to the strong yen.
LINING UP OPTIONS
The central bank's nine-member board started their meeting at 9:00 a.m. (01:00 a.m. BST). Governor Shirakawa will hold a news conference at 2:30 p.m. (06:30 BST), the BOJ said.
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 (151 billion pounds) 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.
The BOJ last eased monetary policy in March, when it doubled the size of the fixed-rate fund supply tool to 20 trillion yen.
(Additional reporting by Linda Sieg, Editing by Nathan Layne & Kazunori Takada)