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Does the Yen’s Pullback Take the Heat Off Bank of Japan?

Friday, 19 Oct 2012 | 2:19 AM ET

Just a month ago traders were on high alert for intervention from Japan to weaken its surging currency. Now that the yen s falling against the dollar, the pressure on Japan to take action has eased, but not for long, said analysts.

Akio Kon | Bloomberg | Getty Images

The yen weakened to 79.45 against the dollar on Thursday, its lowest level in eight weeks and three percent below seven-month peaks hit a month ago.

This should bring some relief to the Bank of Japan (BOJ), which last month surprised markets by easing monetary policy via asset purchases in a move that was widely seen by analysts as designed, in part, to sap yen strength.

(Read More: More Monetary Easing Seen as Japan's Economy Hits a Bump.)

"The slight easing in the yen does take the urgency off further easing from the Bank of Japan," said Ray Attrill, global co-head of foreign exchange strategy at National Australia Bank, in Sydney.

"But the yen is still problematic and it is still overvalued and that is a negative for the Japanese economy," he said, adding that the BOJ was likely to ease monetary policy again soon.

A strong yen has been a constant source of consternation for Japan's policymakers who have been grappling with a deteriorating economic outlook, stubborn deflation and a territorial row with China that has dealt a further blow to exports and manufacturers operating on the mainland.

(Read More: Japan Economy to Contract as China Dispute Bites: JPMorgan.)

While the yen's fall this week is likely to be welcomed in Tokyo, the fact is the currency remains relatively strong and will continue to provide an incentive to ease monetary policy, currency analysts said.

The BOJ, which is next scheduled to meet on October 30, is expected to cut its long-term economic growth and inflation forecasts and analysts said there is a chance the central bank could ease policy again.

Despite its recent falls, the yen is still up about three percent so far this year, making it one of the best performing major global currencies, which means the yen is likely to remain on the BOJ's radar screen, they said.

"There are two ways you can defray natural currency strength, one is to embark on asset purchasing, which is what they are considering doing, possibly at the end of this month," Michael Woolfolk, senior currency strategist at BNY Mellon told CNBC Asia's "Squawk Box" on Friday.

"The second is to lighten up on the proportion of JGBs (Japanese government bonds) held in government portfolios and perhaps buy more international bonds," he added.

Weakness Just a Blip?

The reason not to get too excited about the yen's pullback is that the move is mostly driven by improved sentiment towards risk by investors and that typically benefits currencies such as the Australian dollar at the expense of the yen, analysts said.

(Read More: Risk Is Back as Fund Managers Turn Bullish on Equities)

"The move in the yen is not a structural downward move, it reflects the more positive risk sentiment," said Dominic Bunning, currency strategist at HSBC in Hong Kong.

"As markets head into year-end, there could be more room for the yen to strengthen, since the quantitative easing we've seen out of the U.S. will weaken the dollar to a greater extent than monetary easing in Japan will weaken the yen," Bunning added.

Currency analysts pointed out that even at weaker levels, the yen is not too far away from the record high of 75.50 against the dollar hit late last year. Any strengthening towards 78 from around 79 currently is likely to be met with intervention talk once more, they added.

"Yen strength remains a factor and a move back through the levels seen in the last few months versus the dollar would heighten concerns about intervention," said Bunning.

- By CNBC's Dhara Ranasinghe; Follow her on Twitter: @Dhara CNBC