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Tokyo - Japan's unsuccessful efforts to curtail the strength of the yen illustrates that policy makers are fast running out of options to protect a fragile economy beset by deflation, analysts say.
After calling an emergency meeting in response to government pressure, the Bank of Japan on Monday said it would expand a multi-billion-dollar loan scheme to boost liquidity, amid hopes it would take the heat out of the yen.
Instead the Japanese unit has continued to rise, hammering the shares of exporters exposed to growing currency risk and sending the Nikkei stock index plunging 3.55% to a 16-month low Tuesday.
"We have long believed that the recent trend of a high yen and falling shares would not change, even if the Bank of Japan tries to act," said Tetsuro Okada, advanced senior economist at Japan Research Institute.
"It has proven to be true. There are not many effective options left."
The yen, which last week hit 15-year highs versus the dollar, threatens the export sector crucial to Japan's growth by eroding repatriated profits.
A recent government survey suggested that many companies in Japan were considering moving production overseas if the yen stayed high, casting a shadow over the nation's already slowing growth picture.
It can also prolong a damaging deflationary cycle of falling consumer prices and purchases deferred in hope of further falls, by making imports cheaper.
But analysts question what authorities can do to control a currency whose strength is more a story of weakness elsewhere in the world.
"The yen is rising because of deterioration in the global economy," said Okada.
Contrary to Japan's weakness, the yen is seen as a safe haven in times of financial uncertainty as investors unwind risky positions in the dollar and euro on jitters over their respective economies' health.
In a bid to combat the yen's strength, the Bank of Japan Monday announced its second loan expansion since March, offering ¥10 trillion in six-month low interest loans in addition to ¥20 trillion from December's three-month loan scheme.
Weaken yen, strengthen dollar
But analysts say the BoJ, which has kept rates at 0.1% since the height of the financial crisis, has little room to move. Years of Japanese economic stagnation sapped demand for loans from companies and consumers.
"Financial institutions are already awash with cash and there is no evidence that banks are short of money to lend," noted Julian Jessop of London-based Capital Economics.
"Instead, the weakness of bank credit reflects a lack of demand from firms and households."
Despite crawling out of a severe year-long recession in 2009, Japan's fragile recovery remains beset by deflation, high public debt, weak domestic demand and softening exports.
All of which pose a challenge for Prime Minister Naoto Kan's government and its agenda focused on cutting the industrialised world's biggest public debt, at nearly 200% of GDP.
Kan is also distracted by a battle to retain his job after the ruling Democratic Party of Japan's controversial former number two Ichiro Ozawa put forward his candidacy to lead the party, to be decided in a September 14 poll.
Japan remains under pressure, with weak gross domestic product growth of an annualised 0.4% in the second quarter pointing to a slowdown.
Consumer prices fell for a 17th month in July and household spending rose less than forecast, reports showed last week.
The government on Monday unveiled an $11bn stimulus and announced monetary steps to safeguard a fragile economy and curb the yen's impact, but the currency powered higher to ¥84.12 against the dollar.
Markets remain unmoved by Japan's recent response, which has further undermined Kan's brief tenure as Japan's fifth premier in fewer than four years, analysts say.
"Policy-makers seem to exude helplessness in the face of growing risks to the export-driven recovery," said Macquarie Bank's Richard Jerram.
"The BoJ continues to make token policy changes apparently aimed more at pacifying politicians rather than loosening policy meaningfully."
With options running out, many see the next step by Japan to be full-scale forex intervention to weaken the yen and strengthen the dollar, a move not seen since 2004.
"Foreign exchange intervention seems all that is left to try to keep the recovery on track," said Jerram.
But with the United States and Europe seemingly happy to reap the trade benefits of their weaker currencies, analysts say any such move would be by Japan alone, yielding only short-lived effects.
"Market interventions are effective when financial authorities of major economic powers show unity" in their actions, said Okada. But "no country is willing to increase the value of its currency".
