Japan's finance minister on Tuesday sidestepped questions about intervention to curb yen strength and said markets should determine exchange rates, prompting the currency to rise to an eight-month high against the dollar.

The rise in the yen is raising alarm bells among Japanese policymakers who worry about its impact on deflation and the country's vital exports just as the U.S. and Chinese economies show signs of slowing down.

Prime Minister Naoto Kan said it may be necessary to consider new stimulus steps for the economy given the uncertain outlook, while a Bank of Japan policymaker said he was watching the yen closely.

The yen's rise has raised market speculation of renewed government pressure on the BOJ to relax its already ultra-loose policy to take the edge off the currency's appeal -- something analysts say was behind a policy change in December.

It's more likely for the BOJ to respond, said Thomas Harr, head of Asian FX strategy at Standard Chartered in Singapore.

If there's weaker growth in the United States and China and Japan is stuck in deflation with a strong yen, there will be political pressure on the BOJ.

Concerns that the global economy is faltering just as it has emerged from the worst downturn in decades is causing alarm among policymakers globally.

Federal Reserve Chairman Ben Bernanke said last month that the U.S. central bank would be prepared to take further steps to bolster growth if needed.

Japan has the added headache of a strong currency, which could undermine the export-led recovery in the economy.

Forex rates are decided by markets, Finance Minister Yoshihiko Noda told lawmakers in the financial affairs committee in parliament's lower house.

I will be watching daily market moves closely. I would like to refrain from commenting on whether to intervene or not.

YEN CLIMBS

In the absence of a statement pointing towards intervention, currency dealers pushed the yen to an eight-month high of 85.90 per dollar JPY= on trading platform EBS.

The yen has gained steadily as concerns have grown about the outlook for the U.S. economy.

It is moving closer to 84.82, a 14-year high hit in November that prompted the central bank to check rates in the market, the closest it has been to outright intervention since 2004.

In a 15-month period up to March 2004, Japanese authorities sold 35 trillion yen to curb the yen's strength and support the country's exporting industries.

That has left markets on edge ever since, perceiving a risk of further intervention every time the yen rises to historically high levels.

If the yen's rise is sustained on the back of a U.S. economic slowdown, it may affect the BOJ's main economic scenario, which calls for a moderate recovery in Japan's economy, BOJ board member Ryuzo Miyao said in an interview with the Asahi newspaper.

Asked if there was a need to ease monetary policy further, Miyao said it would depend on whether such market moves would have a crucial effect on Japan's economy.

The BOJ, which has kept interest rates at 0.1 percent since late 2008, eased policy in December and March by first setting up and then expanding a bank funding facility.

Miyao, a lifelong academic and an expert on monetary policy, joined the board in March.

Prime Minister Kan said Japan's economy was improving, but problems in the labour markets are still severe.

There is also uncertainty about overseas economies, so we may be approaching the point where we have to consider if it's necessary to respond in some way, he told lawmakers in reply to questions about an opposition party's proposal for extra stimulus measures.

Japan's economy grew at an annualised rate of 5.0 percent in the first quarter, the second fastest among G7 economies after Canada.

Many economists expect growth to slow for the remainder of this year as a rebound in exports moderates and government subsidies for energy-efficient goods expire. The downturn and weak domestic demand have led to 16 straight months of deflation.

The Bank of Japan and the Federal Reserve meet to review their respective policies on Aug. 10.

The Fed will consider whether to use cash from maturing mortgage-bond holdings to buy new mortgage or Treasury bonds, ploughing money back into the economy rather than allowing its portfolio to shrink gradually, the Wall Street Journal reported.

The BOJ has maintained it is ready to act if the economy deteriorates and analysts think that any change in policy would be minor. (Editing by Edmund Klamann and Charlotte Cooper)

Japan Canada China Ben Bernanke