Sharp yen gains sparked by fears of political deadlock in Italy are a wake-up call to investors and a challenge to Prime Minister Shinzo Abe, whose demand for drastic monetary easing has sent the Japanese currency tumbling.
Abe won a big election victory in December promising aggressive policies to end deflation and revive economic growth. The fall in the yen has begun to help exporters.
But Monday's sudden spike in the yen was a reminder Japan is seen by many investors as a safe haven in times of uncertainty, which will limit the impact of Japan's monetary policy easing on the currency. Some investors also say the Bank of Japan will struggle to live up to expectations of bold new stimulus.
Japanese officials remained silent on Tuesday on the yen spike in the wake of elections in Italy that showed no group had a clear majority in parliament, an uncertainty resurrecting fresh euro zone debt fears for investors.
Some analysts said there was little the Japanese government or the Bank of Japan could do.
"Many market participants are expecting bold monetary easing from the BOJ but such expectations could turn out to be an illusion," said Soichiro Monji, chief strategist at Daiwa SB Investments.
The yen had its biggest daily gain against the dollar and the euro since May 2010 on Monday, with the euro falling a whopping 5 percent in six hours to a one-month low of 118.74 yen . The dollar fell to as low as 90.85 yen from a 33-month high of 94.77 yen.
That was the yen's first major gain since a steep decline that began in November, when Abe called for dramatic monetary easing while he was the opposition leader.
The Japanese currency has dropped as much as 16 percent versus the dollar and 21 percent against the euro since then. At the same time, Japanese stocks have surged 27 percent.
In a sign of growing scepticism about Abe's policies, dubbed "Abenomics", some investors have begun buying yen call options, the right to buy yen at a pre-determined price, often a strategy to hedge against a potential rise in the currency.
The dollar/yen's risk reversal spreads show that in the past week or so yen call options became more expensive than yen put options, which give the right to sell the yen, for the first time in almost six months.
(Read More: Does Japan Really Need $100 Billion in Spending?)
"We have tended to view developments at the BOJ as too much talk and not enough action," said Robert Rennie, chief currency strategist at Westpac Bank in Sydney, who made a recommendation to buy yen calls on February 13.
Abe and other Japanese ministers sought to talk down the yen earlier this month but analysts noted they went quiet after a meeting of financial leaders from the Group of 20 industrial nations in Moscow.
Although a G-20 statement did not single out Japan as trying to weaken the yen to gain a competitive edge, many analysts think pressure was put on Tokyo to avoid verbal intervention.
"It's becoming clear that they can no longer keep trying to talk down the yen as they used to, given what other countries are saying about the yen's decline," said Daisuke Uno, chief strategist at Sumitomo Mitsui Bank.
Japan has denied it was trying to weaken the yen, saying all it wanted was to ease monetary policy to end deflation.
Time for Action
Many investors are waiting for the appointment of a new governor at the BOJ after the current chief, Masaaki Shirakawa, steps down next month.
Abe is expected to nominate Haruhiko Kuroda, head of the Asian Development Bank and an advocate of aggressive easing. That would mean the bank's first policy review under Kuroda would take place on April 3-4.
Kuroda has long criticized the BOJ as too slow to expand stimulus, and is expected to push for more radical efforts to achieve a 2 percent inflation target set in January.
Some analysts say the BOJ might disappoint.
Westpac's Rennie said the BOJ would need to triple its planned asset purchases this year of about 36 trillion yen if it just wanted the pace of its balance sheet expansion to match that of the U.S. Federal Reserve.
"That can be done either through an intense lengthening of the maturity of assets being purchased or through increased monthly purchases. Either way, huge expectations have been built into the yen. I am just not sure that the BOJ can live up to those expectations," he said.
Abe has also toned down his comments on a plan to set up a fund to buy foreign bonds, saying last week the need for such a body had declined.
"It appears that Abe is already seeking an exit strategy for his plan. He praised the BOJ for taking bold steps when the BOJ adopted inflation-targeting. For him, bold easing is probably already in place," Monji said.