The Bank of Japan expanded its cheap loan scheme on Monday, heeding government calls for action to curb a rise in the yen that threatens a fragile economic recovery and leaving the door open to more policy easing.

The yen surged more than 1 percent against the dollar after the central bank beefed up the supply of fixed-rate loans to banks, a move investors saw as a symbolic gesture that will do little to halt a climb in the currency that hurts exports and may prolong deflation.

Today's move is not a bold move, said Simon Wong, regional economist at Standard Chartered Bank in Hong Kong. If the yen continues to appreciate, say it appreciates beyond the 80 level, that could trigger more direct intervention at some point.

The decision at an emergency meeting called a week ahead of a scheduled policy review follows weeks of efforts by Tokyo's policymakers to talk down the yen, which intensified after the yen hit a 15-year high of 83.58 yen against the dollar last week.

Aware of slim chances of a coordinated market intervention and risks of taking on markets alone, the government stepped up its pressure on the central bank to curb the yen with some form of monetary easing. Now, however, the ball was back in the government's court, analysts said.

They don't really have any other policy tools they are prepared to use, so that might make it more necessary to have intervention if the yen goes, said Richard Jerram, chief economist at Macquarie Securities in Tokyo.

Market players were disappointed the BOJ had stopped short of more aggressive moves such as increasing Japanese government bond purchases or cutting its overnight rate call target from 0.1 percent to zero.

BOJ Governor Masaaki Shirakawa said told a news conference the current level of bond buying was appropriate. He also said, however, the central bank could not rule out downgrading its forecast of a moderate economic recovery -- a hint that it might act again if clearer evidence of a slowdown emerged.

PM KAN KEEN TO LOOK ACTIVE

The yen's rebound pulled the Nikkei share average off its peaks and helped Japanese government bond futures bounce back from an early plunge.

Prime Minister Naoto Kan, whose Democratic Party swept to power a year ago but was thrashed in a July upper house poll, is keen to show that he is doing something about the economy ahead of a challenge from powerbroker Ichiro Ozawa in a September 14 party leadership vote that could split the party.

Kan was to meet Shirakawa after the policy board meeting, and his cabinet was to decide the basic thrust of additional measures to help the slowing economy at a meeting later in the day.

The government's fiscal policy and the BOJ's monetary policy should be in sync to send a strong message, Trade Minister Masayuki Naoshima told reporters.

But Japan's huge public debt, now twice the size of the economy, limits Tokyo's options, and the government is expected to propose shifting funds around rather than announce new substantial spending.

FLYING SOLO?

Japan will probably have to intervene alone if it were to step in to curb yen gains, as its Group of Seven counterparts, happy with the benefits to exports from their weak currencies, are in no mood for coordinated intervention.

Solo currency intervention, however, will not have much effect in weakening the yen unless backed by aggressive monetary easing, traders say.

In Monday's move, the central bank increased the volume of money available to banks under its fixed-rate fund supply operation to 30 trillion yen ($351 billion) from 20 trillion yen.

It also put in place a six-month fund operation in addition to the three-month loan programme already in place.

Of the 30 trillion yen, 10 trillion yen will be the six-month fund operation, BOJ said. The decision was by an 8-1 vote, with board member Miyako Suda dissenting.

The central bank, as widely expected, maintained its overnight core rate target at 0.1 percent by a unanimous vote.

The BOJ launched the funding scheme, which offers loans at 0.1 percent, in December. That failed to boost bank lending but helped to push the yen further away from a November high.

The BOJ last eased monetary policy in March, when it doubled the size of the fixed-rate fund supply tool to 20 trillion yen.

($1=85.37 Yen)

(Writing by Leika Kihara and Linda Sieg; additional reporting by Tetsushi Kajimoto; Editing by Edmund Klamann and Tomasz Janowski)

Japan Bank of Japan Quantitative easing