* Bets against yen rise as political pressure mounts on BOJ to ease aggressively
* Some analysts believe yen could weaken about 10 pct based on purchasing power
* Deteriorating trade balance also underlying factor for softer yen
* Key test lies at March low of 84.187 yen per dollar
* Heavy use of options to sell yen suggests limited risk of sharp rebound
By Hideyuki Sano
TOKYO, Nov 27 The yen's four percent decline in less than two weeks could herald a longer-term trend as investors have begun pricing in a possible game-changing shift in monetary policy after Japan's Dec. 16 election as the likely winner favours aggressive easing.
Shinzo Abe, the leader of the main opposition Liberal Democratic Party, wants the Bank of Japan to set an inflation target of 2 percent, and embark on "unlimited easing", adopting negative interest rates and printing more money.
"The Liberal Democrats want to change the rules," said Andrew Wilkinson, chief economic strategist at Miller Tabak & Co in New York. "When you have a sea change like this, then it's very possible you'll get a sharp change in both speculative and commercial, corporate sentiment in the yen."
The yen stood at 82.10 yen to the dollar on Tuesday, weakening from 79.40 yen in mid-November, when Prime Minister Yoshihiko Noda finally gave in to pressures for an early election.
There are plenty of critics of Abe's ideas, both within the BOJ and the broader business community, raising the possibility that some proposals might be watered down or completely dropped.
But if Abe does reclaim the premiership he last held in 207, he would also be able to pick a new central bank chief when Masaaki Shirakawa's term as governor ends in April.
Abe has also threatened to change the law to take away the Bank of Japan's independence so the government can impose a pro-growth agenda.
Eiji Kinouchi, chief technical analyst at Daiwa securities, said adopting a 2 percent inflation target potentially held significant implications for the yen.
"Calculating from the past correlation between yen's exchange rate and inflation expectations shown in inflation-linked bonds, if inflation expectations hit two percent, the yen could weaken another 15 percent," Kinouchi said.
"So we are not talking about the yen's fall to just around 84 yen. If inflation expectations do rise, even though that is a big if, the yen could weaken to around 95 yen," he said.
GOOD FOR EXPORTERS, SHARES
The moderation in the yen's strength is a blessing for the corporate sector as Japan's export reliant economy struggles to avoid a recession that many economists say has already begun.
Due to fallout from a diplomatic dispute with China and sluggish global demand, exports fell in annual terms for a fifth month in October, with firms like Toyota Motor Corp and camera and printer maker Canon Inc handicapped by the yen's strength.
Analysts estimate that for every one yen rise in the yen/dollar exchange rate, combined recurring profits at all the listed Japanese firms would rise about one percent.
And further yen weakness should help boost shares of long-suffering exporters and further lift a Tokyo's Nikkei stock average that has gained more than 8 percent since the election was called in mid-November.
Shares of Sony, Panasonic and Sharp are all struggling near three decade lows due to the hi-tech sector's loss of competitiveness.
2.5 PCT AWAY FROM CRUCIAL TEST
The yen had struck a record high of 75.311 per dollar in October last year because of the currency's status as a safe-haven, while the global economy lurched from crisis to crisis, first in the U.S. mortgage debt market and then in European debt market.
The yen hit a low for the year of 84.187 to the dollar in March, after a six-week slide brought about by expectations of BOJ easing finally fizzled out.
To convincingly establish a bearish trend and break an uptrend that has been in place since June 2007, analysts say, the yen will have to weaken beyond the March low. It has 2.5 percent further to go to test that level.
Analysts say the yen still looks about 10 percent overvalued compared to its purchasing power parity, leading some market players to think the yen could possibly weaken to at least around 90 yen per dollar.
Wilkinson went further. He expected the yen to test 100 to the dollar within 2013, a level not seen since 2009, and possibly by next June, if the new government is proactive in persuading the central bank to take aggressive easing steps.
The yen's status as a safe haven is also being eroded by Japan's deteriorating balance of payments position, and a increased dependence on imported fossil fuels after the shutting down of most of the country's nuclear power plants after last year's nuclear disaster.
So far, traders say the yen's recent slide has been mostly driven by speculators, especially momentum-chasing hedge funds, who will eventually need to cover their positions, suggesting the currency could rebound sharply.
Indeed, U.S. regulator's data showed on Monday that net yen short positions in the Chicago futures market have already soared to over 50,000 contracts, not far from peaks around 60,000 contracts seen a few times in recent years.
But speculators are heavily using options rather than selling the yen outright, so they will be under less pressure to buy back yen should the market move against them, limiting the risk of a sharp reversal, said a trader at a European bank.