How low will yen go? Depends on the dollar

What's fueling the greenback's uptrend?

The resurgent U.S. dollar has trumped most major currencies in its march higher, not least the Japanese yen, whose recent slide against the greenback is raising policymakers' eyebrows.

Dollar-yen spiked to a six-year high this week, touching a high of 106.46 on Tuesday. The move triggered warnings by Finance Minister Taro Aso and Economics Minister Akira Amari, who cautioned that further sharp declines in the currency are not desirable.

The yen's near-term outlook hinges on the direction of the U.S. dollar, say analysts, who expect further downside in the Japanese currency.

Read MoreInterest rate worries hang over stocks

"The U.S. dollar index is approaching early 2013 highs, a break of which would see it trade at its highest since 2010. Japan has perhaps been the biggest beneficiary of this," said Stan Shamu, market strategist at IG.

The greenback has stormed higher on a strengthening American economy and the prospect of higher U.S. interest rates as the Federal Reserve unwinds its easy monetary policy.

Odds are rising that the Fed could make an important change to its policy statement at its meeting next week which markets will see as a cue that rate hikes are coming sooner than expected.

"The U.S. is recovering – the question is the pace, and not the direction," added Callum Henderson, global head of FX research at Standard Chartered.

Read MoreA Fed phrase change could mean rates hikes sooner

By contrast, the – which has hovered around the 102 level against the dollar for much of this year – saw a pronounced sell-off in the last month, falling over 4 percent against the greenback.

According to Emma Lawson, senior currency strategist at the National Australia Bank, the yen has also been hampered by soft economic data and increasing chatter than the Bank of Japan (BoJ) may step in with more stimulus to support the economy.

U.S. and Japanese national flags sit on display in front of a monitor displaying the exchange rate of the yen against the U.S. dollar at a foreign exchange brokerage in Tokyo, Japan.
Kiyoshi Ota | Bloomberg | Getty Images

"The yen is an under-performer due to the increased risk of more QQE (quantitative and qualitative easing) from the BoJ, the relative under-performance of the economy and the structural deterioration in the external accounts," said Lawson, who has a year-end dollar-yen target of 108.

While a weak currency is generally positive for an economy like Japan that relies heavily on exports, the soft yen has yet to boost exports in a big way. Exports rose for the first time in three months in July, but it's unclear if the momentum will continue as Japanese companies have been slow to expand their businesses.

There are also concerns a weak yen would be counterproductive for corporate Japan as it raises the import costs of fuel and raw materials, although most analysts aren't too worried at this point.

Read MoreJapan Q2 contraction worse than initially expected

"A weakening of the currency takes time to work through the economy, but it will be welcomed. The authorities have already warned on sharp moves in the currency – they prefer a weaker yen but not volatile changes. These are typical comments," said Lawson.

On a technical basis, Stanchart's Henderson says the dollar-yen's steady climb this year signals further gains to come.

"Our forecast for the year end is 106 but certainly there is risk to the upside to that," said Stanchart's Henderson. "What's impressive about this rise in dollar-yen is the very gradual nature of it. Typically, when you see the end of the trend, you see accelerated gains. We haven't seen that yet."