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Fate of yen hinges on Japan’s weekend elections

The Asahi Shimbun - Getty Images

The much-anticipated upper house elections in Japan on Sunday will be pivotal to shaping the fate of the country's currency, which has experienced wild swings in recent months, analysts told CNBC.

Volatility in the yen has kept markets captivated all year. The Japanese currency has fallen about 25 percent against the dollar since mid-November last year when Prime Minister Shinzo Abe first unveiled his intentions for a radical plan to revive the Japanese economy.

(Read More: Abenomics Vindicated? Still Too Early to Tell)

Dollar-yen breached the psychologically important 100 level in May before doubts over the viability of Abe's radical policies and the prospect of U.S. Federal Reserve unwinding its massive monetary stimulus took a toll, bringing the cross back down to the current 93.7 level.

Where the currency pair goes from here, hinges on the outcome of the upper house elections on July 21, analysts say. If Abe's Liberal Democratic Party (LDP) can gain a majority it should give him extra impetus to push his third arrow through.

"Sunday's a big day [for the yen]," Robert Rennie, global head of currency strategy at Australia's Westpac bank told CNBC. "Presumably Abe wins the majority in the upper house and that gives him the mandate to move forward with his third arrow," he added.

Abe's policy agenda involves a three-pronged approach of aggressive monetary stimulus, fiscal spending and structural reforms. While investors have cheered the details of the monetary and fiscal plans, which have helped the stock market surge 40 percent so far this year, successful implementation of the structural reforms, or the "third arrow," will depend on how Abe fares in this weekend's vote.

(Read More: Japan Fires 'Third Arrow,' but Will It Work?)

"If they [the upper house elections] do deliver a resounding victory for the LDP, it means the third arrow of 'Abenomics' can proceed apace," said Ray Attrill, co-head of FX Strategy of Fixed income, currencies and commodities at National Australia Bank.

According to Westpac's Rennie, the speed at which Abe is able to push through his policy initiatives, which involve raising incomes by 3 percent annually over the next decade, setting up special economic zones to attract foreign investment and full liberalization of the retail electricity market, will also be important for the currency.

"How quickly we see fresh developments coming through will be important in shaping the yen through the second half of this year," he said.

A win on Sunday could prove the catalyst to push the dollar-yen past 100 again, said Attrill.

(Read More: Dollar-Yen Back Above 100, but This Time It's Different)

"If the Japanese stock market responds positively to that [an Abe win], that could be the catalyst to make the dollar-yen finally break back past 100 and make progress towards the 105 area," he said.

Campaigning for the upper house elections began earlier this month.

A total of 433 candidates are set to compete for 121 open seats in the 242-seat upper house. The ruling coalition needs 63 seats to gain a majority and if they are successful the LDP will gain single party dominance in both Japan's houses of parliament.

Abe's high popularity ratings suggest that a win is likely.

Abe was previously elected in as prime minister in 2006, but resigned a year later after he was defeated in upper house elections.

—By CNBC's Katie Holliday: Follow her on Twitter @hollidaykatie