Japan kept markets on guard for currency intervention and more monetary easing on Wednesday, with the finance minister vowing to stem the yen's rise and the prime minister calling for central bank action to protect the economy.
The yen held broadly steady against the dollar as recent repeated jawboning by Japanese authorities kept markets wary of intervention, while a deal to raise the U.S. debt limit eased pressure on the U.S. currency.
While verbal intervention reached fever pitch, Prime Minister Naoto Kan called for the Bank of Japan's support a day before its two-day rate review, a sign that monetary loosening could be on the cards even if Tokyo chooses to hold off with selling yen just yet.
Japan's economy is in the process of recovering from disaster, so we must closely watch currency moves. We want the BOJ to continue to support the economy, Kan told a regular meeting of cabinet ministers to discuss risks to the economy, which the central bank governor attended.
Japanese officials fear that the currency's near 5 percent surge in the past month will harm the economy, which skidded into its second recession in three years following the March 11 earthquake and tsunami.
BOJ Governor Masaaki Shirakawa signaled the central bank's readiness to ease policy this week, saying the board will scrutinize the negative impact that recent yen gains could have on the economy.
Lingering worries that the United States faces a ratings downgrade and that Europe's debt crisis will spread further could push the yen higher again, forcing Japan to sell its currency for the third time in about a year.
I don't think currency markets are reflecting economic fundamentals at all, Finance Minister Yoshihiko Noda told lawmakers on Wednesday, threatening possible intervention.
He declined to comment on whether Tokyo would intervene, including the timing of any such move, but warned that if Japan were to step in it would aim for maximum effect.
Swiss policymakers on Wednesday cut the target interest rate to stem gains in their rapidly rising currency, which like the yen is also considered a haven in times of financial stress, and warned they would take further steps if needed.
Kan's rare request for BOJ action likely means the central bank will ease policy on Friday even if it precedes any currency intervention by the finance ministry, analysts said.
The fall in Japan's Nikkei average for a second day on Wednesday also heightened the chance of monetary easing as it could hurt business sentiment, which the BOJ focuses on in determining whether to ease.
The yen hovered around 77.16 yen to the dollar, after it soared on Monday within a hair's breadth of March's record high of 76.25 yen. Japanese government bonds jumped partly on expectations of monetary easing this week.
If the BOJ were to ease, it will likely top up its 10 trillion yen ($130 billion) asset buying scheme, under which it buys government bonds and private debt, by 5 trillion yen. Most of the increase will be in JGBs and corporate bonds given the relatively big size of these markets in Japan.
EYES ON U.S.
Moody's Investors Service said it had confirmed the United States' top AAA rating but assigned it a negative outlook after lawmakers passed a deal to raise the U.S. borrowing limit and reduce the deficit.
Despite the debt agreement, the dollar was unable to make much headway, weighed down by worries about the health of the U.S. economy following a batch of dour data.
Markets also await possible action by ratings agency Standard & Poor's, which has yet to give its opinion of the debt deal hammered out in Washington that many predict will include a cut in its top rating for the world's biggest economy.
Japan has been priming the markets for currency intervention since the yen tested its record high, signaling it may try to tame the currency with a combination of yen-selling and monetary easing.
Japan last intervened in concert with the Group of Seven in March when expectations of fund repatriation after the earthquake pushed the yen to a record high.
This time, most market players believe Japan would have to go it alone since the yen's gains are more about dollar weakness than anything else. Tokyo last acted solo in September 2010, when it sold 2.1 trillion yen.
($1 = 77.145 Japanese Yen)
(Additional reporting by Rie Ishiguro, Editing by Tomasz Janowski)