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Here’s what could really knock the yen back down

Akio Kon | Bloomberg | Getty Images

As Japan's yen continued to strengthen against the dollar this week, some analysts suggested that further monetary stimulus from the Bank of Japan was needed to put the currency back on its downward track.

The yen was trading at 97.94 per dollar late on Tuesday, hovering near a one-month peak hit on Monday. It is up more than 3.5 percent from a high hit earlier in July.

"The price action on dollar/yen has been a bit worrying and this is looking a little bit like catching a falling knife," Sean Callow, senior currency strategist at Westpac, told CNBC.

(Read More: Japan's sales tax debate could hit the Nikkei)

Aggressive monetary easing and optimism about Japan's economic outlook have helped drive the yen lower against the dollar this year. Its weakness is a central part of Prime Minister Shinzo Abe's plans to revive the Japanese economy, which has been held back by two decades of deflation.

But some analysts warned that Abe's economic policies have helped push the Japanese currency back up against the dollar in recent weeks, and that strength has dealt a blow to Japanese stocks. They said that if Japan's policymakers are serious about delivering a weak yen, then they may have to step up their monetary stimulus efforts.

"Firmer data is being misinterpreted as a sign that the Bank of Japan (BOJ) won't do any more stimulus. We think it will have to, and that should help weaken the yen," said Mizuho Corporate Bank Market Economist Vishnu Varathan.

While the general tone of recent Japanese data has pointed to a pick-up in the economy, there have been some signs of weakness. Data on Tuesday for instance showed industrial output fell by a bigger-than-expected 3.3 percent in June, month-on-month, while household spending for the month fell 2 percent, despite expectations for a rise.

(Read More: Could Japan fall back into recession next year?)

"The industrial production report is not good news for Abenomics, however it does suggest the BOJ will need to put its foot down slightly firmer on the easing peddle," Chris Weston, chief markets strategist at trading firm IG, said in a note. Abenomics is the term now widely used to describe Abe's radical economic policies.

According to Callow, it might be some time yet before the BOJ gives any more indication of its plans for Japanese monetary policy. The central bank in April said it would pump $1.4 trillion into the economy by the end of 2014 to help Japan get back on its feet.

"The Bank of Japan is pretty happy with the way the numbers are stacking up for the most part, and it needs more time, and I don't think we're going to get an exciting BOJ meeting until October, when it releases its semi-annual report," said Callow.

(Read More: Is the Japanese foreign bond binge finally under way?)

Currency strategists are standing by their forecasts for a weakening in the yen long-term, especially amid signs Japanese investors are stepping up their buying of foreign assets.

"As long as data can stabilize and outflows out of Japan continue, the yen should head lower," Callow said.

— By CNBC.Com's Dhara Ranasinghe; follow her on Twitter @DharaCNBC