The Bank of Japan will likely consider easing monetary policy next week to support its export-reliant economy, if yen rises persist following the U.S. Federal Reserve's stimulus measures, according to analysts and sources familiar with the BOJ's thinking.
The central bank is also expected to offer a bleaker view of the economy than it did last month, when it said growth was starting to pick up moderately, as Europe's debt crisis and slowing demand in China weigh on exports, the sources said.
Some analysts see an increased likelihood that the BOJ will act next week to tame a stubbornly strong yen, although it is hardly a foregone conclusion because of reluctance within the central bank to use its limited policy options so soon.
The decision will likely be a close call. Bank policymakers are expected to scrutinize yen moves leading up to the two-day meeting, which ends on Wednesday, in reaching a decision on whether to take additional easing steps.
Finance Minister Jun Azumi repeated his warning to markets against pushing up the yen too much, saying authorities would take decisive action if necessary and won't rule out any measures - a thinly veiled threat of currency intervention.
"Recent one-sided yen gains clearly do not reflect Japan's economic fundamentals," Azumi told a news conference on Friday.
With slowing global demand already clouding prospects of a near-term recovery, the BOJ is also more sensitive to the pain from a strong yen and may thus act pre-emotively to minimize the damage from yen rises on business sentiment, analysts say.
"The likelihood of the BOJ easing next week has heightened after the Fed's move," said Hideo Kumano, chief economist at Dai-ichi Life Research Institute in Tokyo.
"If the yen rises on Monday, when Japanese markets are closed for a national holiday, the BOJ may loosen policy in tandem with currency intervention by the government," he said.
If the BOJ were to act, its most likely option would be to expand its main monetary easing tool, a 70-trillion-yen ($904 billion) asset buying and loan program, by 5 trillion or 10 trillion yen with most of the increase to be for purchases of government bonds, analysts say.
MOOD CHANGE POST-FED
In an escalated effort to boost growth, the Fed pledged on Thursday to buy $40 billion of mortgage debt per month and continue to purchase those and other assets until the outlook for jobs shows marked improvement.
The dollar briefly fell to 77.13 yen, its weakest since early February, on Thursday after the Fed's announcement, although it bounced back above 78 yen on Friday.
The BOJ had initially expected to hold off on loosening policy until next month, when it makes a more thorough analysis of whether Japan's economic recovery will be delayed enough to warrant further stimulus.
But the mood changed after the Fed revealed its aggressive asset-buying plan. The government, which cut its assessment of the economy for the second straight month, pressured the BOJ to expand stimulus to counter growing headwinds such as a stubbornly strong yen and slowing global demand.
"Overseas developments must be taken into account in guiding economic policy, including monetary policy," Economics Minister Motohisa Furukawa told a news conference when asked whether the BOJ should follow the Fed and ease policy next week.
Azumi also said he hoped the central bank would "respond as appropriate" to signs of economic weakness, taking into account the government's economic assessment.
Japanese government bond prices rose on Friday due to growing expectations the BOJ would follow the Fed's steps with some stimulus action of its own.
BOJ UNDER HEAT
The world's third-largest economy expanded less than expected in the second quarter and analysts now expect growth to stall for the rest of this year as Europe's debt crisis and subdued Chinese growth cloud the outlook.
Akio Toyoda, head of Japan's automobile lobby, called for bolder government and BOJ action to stem yen rises, warning on Friday that if the yen stayed too strong, companies may no longer be able to cover the pain with cost cuts.
But while policymakers repeatedly threaten intervention, Tokyo has refrained from stepping into the market after spending 9 trillion yen in unilateral action late last year.
Market players say Japan won't be able to intervene again easily given the international criticism it provokes, making further monetary easing the more likely option.
BOJ Governor Masaaki Shirakawa already faced calls for bolder action in a meeting to discuss the government's monthly economic report, with one cabinet minister urging the central bank to opt for a big, Fed-style stimulus.
Shirakawa declined to comment on what the BOJ could do next week, only replying that it would guide policy appropriately, according to a government official present at the meeting.
But he told business leaders last month that yen rises posed a "big negative impact on the economy", in a sign of how mindful the BOJ was of the pain from a strong yen.
The BOJ set a 1 percent inflation target and loosened policy via an increase in asset purchases in February, and followed up with another easing in April. It has stood pat since then.
Even if it holds fire next week, the BOJ is expected to offer a bleaker view of the economy than last month, and cut its assessment on exports and output, keeping alive expectations of near-term easing.
(Additional reporting by Tetsushi Kajimoto, Kaori Kaneko and Yoko Kubota; Editing by Michael Watson and Simon Cameron-Moore)