TOKYO The Bank of Japan will consider easing monetary policy further, possibly at an emergency meeting before next month's rate review, if further rises in the yen push down Tokyo stock prices enough to hit business sentiment, sources said.
The government may also intervene unilaterally again in the currency market to weaken the yen, although analysts doubt whether such moves can alter a broad weak dollar trend.
A senior government official expressed Tokyo's readiness to step into the currency market to stem yen rises if necessary, saying that recent moves have been speculative.
"Japan's stance is consistent in that it will take decisive action depending on market developments," the official told Reuters on Sunday.
The central bank loosened policy just two weeks ago to ease the pain of persistent yen strength on the export-reliant economy, and has expressed its readiness to act again if the prospects of a moderate economic recovery come under threat.
After the yen rose to a fresh record high against the dollar last Friday, BOJ officials will scrutinize Asian market moves on Monday and start debating whether the potential harm from recent yen gains warrants further policy action.
The BOJ's next regular rate review is on September 6-7.
But the chance of it easing its already super-loose policy before that cannot be ruled out, depending on market developments, sources familiar with the BOJ's thinking say.
"We will act swiftly, if needed, with an eye on economic conditions," one of the sources said.
Still, a brief yen spike to fresh records alone would not trigger immediate BOJ action.
For the BOJ to call an emergency policy meeting, it would take a sustained yen rise above 76 to the dollar, accompanied by falls in Tokyo stock prices that are sharp enough to hurt business confidence, the sources say.
"The BOJ doesn't target currency rates but deals with the effect of exchange rate moves. The trigger for monetary easing would be a severe deterioration in sentiment," another source said. Both sources spoke on condition of anonymity due to the sensitivity of the matter.
If the BOJ were to ease policy, the most likely option would be to expand its 50 trillion yen ($656 billion) pool of funds to buy government and private assets and offer cheap fixed-rate funds via market operations. The pool was expanded when the BOJ eased policy earlier this month.
FIRMS FEELING THE PAIN
Tokyo intervened unilaterally in the currency market and eased monetary policy on August 4. But the steps have not stopped investors from seeking the yen as a safe haven against risk, with the dollar hitting a record low of 75.95 yen on Friday. It later bounced back above 76 yen.
Japanese policymakers have continued to issue verbal warnings to markets against pushing the yen up too high, and do not rule out intervening again if they see moves as speculative.
But the effectiveness of any solo intervention would be limited, with very little chance that Japan's G7 partners would agree to jointly step into the market to halt a grinding rise in the yen, analysts say.
Some in the government and the BOJ are cautious about using their depleted policy options now, given a host of events that could easily wipe out the impact of any steps they take.
Among them is Federal Reserve Chairman Ben Bernanke's speech on August 26 at Jackson Hole, Wyoming, where he may signal the chance of further monetary stimulus, and U.S. payrolls data on September 2.
The government, however, cannot afford to stand pat, mainly for domestic reasons. The dollar is well below the 80 yen level that many exporters made the basis for their earnings forecasts for the current financial year to next March.
Many Japanese exporters, who over the years have cut costs to offset the damage from yen gains, say current yen rises are beyond what they can take and may shift production overseas.
A strong yen has benefits such as cutting import costs and making overseas M&A cheaper for Japanese firms. But a yen rise now is painful for many manufacturers banking on a swift recovery in the second half of this year, when supply constraints from the March earthquake and tsunami ease.
Toyota Motor Corp (7203.T), Japan's biggest car maker, says every 1 yen rise against the dollar cuts its annual operating profit by 30 billion yen. Honda Motor Co (7267.T), the country's third-biggest auto maker, is studying possible production bases overseas to replace export-bound car production in Japan.
"Protecting Japanese manufacturing and building cars here is becoming more and more difficult," Honda Chief Financial Officer Fumihiko Ike said earlier this month.
The government plans to come up with a package of steps to ease the pain in a third extra budget, such as offering cheap loans to small firms hit by the yen's rise.
But progress may be slow as ruling party lawmakers are maneuvering to select a successor to unpopular Prime Minister Naoto Kan, who is expected to step down as early as the end of this month.
With at least seven ruling party lawmakers -- including Finance Minister Yoshihiko Noda -- eyeing the nation's top job, the outlook for who will take the helm is unclear, as well as how the next leader will address the yen's rise.
($1 = 76.245 Japanese Yen)
(Additional reporting by Taiga Uranaka, Linda Sieg and Tokyo policy team; Editing by Yoko Nishikawa and Edmund Klamann)