Japan on Friday escalated its warning to financial markets against testing the yen's upside further, with the finance ministry signaling that Tokyo may not wait for too long with action if the currency keeps climbing.

In his strongest threat of intervention so far, Finance Minister Yoshihiko Noda said that the yen was rising "too much" and deviating from Japan's economic fundamentals.

"Our stance is clear. We will take decisive action against excessive exchange rate volatility," Noda told parliament.

"I'd like to carefully examine how long we can leave current (exchange-rate) moves unattended."

Markets feel that Tokyo's verbal warnings have reached a higher pitch and see intervention as a real possibility, but not until the yen accelerates toward its record high against the dollar.

With the yen's rise driven by factors beyond Japan's control such as the U.S. debt crisis, there is still no full agreement among monetary authorities on whether and when to intervene, sources familiar with the government's exchange-rate policy say.

The likelihood of action may depend on the outcome of a tussle between government officials sensitive to business complaints who would prefer swift action, and those who work with G7 partners and are hesitant of stepping in too hastily, said one of the sources who spoke on condition of anonymity. Another source confirmed this view.

Any currency intervention would increase the chance of the Bank of Japan following up with monetary easing, as was the case when Japan last intervened on its own in September, the sources said.

In a nudge toward the Bank of Japan, Noda said he hoped to take appropriate action "in cooperation" with the central bank, to address the currency's rise that was hurting exporters and threatening Japan's recovery from damage wrought by the March 11 earthquake and tsunami.

Data on Friday showed factory output rose further in June and manufacturers expected more gains in July and August that would bring production close to pre-quake levels, but economists said the yen's rise was clouding the outlook.

Policymakers' repeated verbal warnings have not prevented the dollar from sliding toward the record low of 76.25 yen struck in March on fears of a U.S. debt default or credit downgrade.

It hit another four-month low of 77.48 yen on Friday morning after Republican Representative Kevin McCarthy said the House of Representatives will delay a vote to raise the U.S. debt ceiling.

A senior BOJ official said the central bank was focusing on how recent yen rises could affect a still fragile economic recovery, suggesting its readiness to ease monetary policy further as early as next week if the yen climbs further.

SOLO ACTION

Markets rule out a repeat of the co-ordinated intervention that the Group of Seven carried out in the aftermath of the March quake, but some see solo action by Tokyo as a possibility.

Japanese policymakers, alarmed at the persistent nature of yen rises amid broad-based weakness in the dollar, see solo action as an increasingly viable option, although markets are skeptical how long its effect would last.

"Noda's verbal warning has escalated slightly," said Michiyoshi Kato, senior vice president at forex sales at Mizuho Corporate Bank.

"It's not about dollar/yen levels alone. Authorities are probably also watching stock markets. If the U.S. debt problem triggers risk aversion and pushes the yen up suddenly, and if that increases worries about the impact on Japan's economy, Tokyo may act."

Policymakers who are hesitant about intervention have pointed to the resilience of the stock market as a sign that the damage to the economy has been contained so far.

But the Nikkei average fell below the psychologically important 10,000 mark on Friday and business lobbies have started to complain more vocally about the government's inaction over the strong yen. Noda said he was aware of business concerns.

The BOJ feels the yen rise has yet to severely undermine business sentiment but is prepared to ease policy further next week if the standoff in U.S. debt talks roils global markets.

"We need to watch out for the negative impact yen rises could have on the economy through exports, corporate revenues and a worsening of business sentiment," BOJ Executive Director Masayoshi Amamiya told parliament on Friday.

Japan's economy is expected to exit recession and grow moderately in July-September as companies make steady progress restoring supply chains hit by the quake.

(Additional reporting by Tetsushi Kajimoto, Stanley White, Rie Ishiguro and Kaori Kaneko; Editing by Tomasz Janowski)