Japan primed financial markets on Tuesday for currency intervention after the yen tested record highs, signaling it may try to tame the unit with a combination of yen-selling and monetary easing.

A near 5 percent surge in the yen in the past month has raised concerns among exporters such as Toyota Motor <7203.T> that the currency's strength will harm the economy, already in recession following the March earthquake and tsunami.

The yen traded as high as 76.29 per dollar on the EBS platform on Monday, near its March record high of 76.25.

Even as it pulled back to 77.40 on Tuesday, Japanese officials adopted a new, more direct tone, suggesting they were increasingly convinced markets needed a nudge to keep the yen at levels the economy could live with.

The yen is being valued stronger than we think ... I'd like to watch currency market conditions especially carefully today, Finance Minister Yoshihiko Noda told parliament.

Reinforcing a sense of urgency, the central bank will probably ease its monetary policy if the finance ministry decided to intervene and sell yen, sources familiar with the central bank's thinking told Reuters.

There is no hard evidence yet that the currency is hurting economic activity and confidence.

But Japanese exporters have been increasingly vocal in calling for official action.

Toyota, Japan's biggest carmaker, reported its first quarterly loss in two years on Tuesday. The company exports more than half the cars it makes in Japan and says every one yen drop in the dollar cuts its annual operating profit by 30 billion yen ($390 million).

The yen rise has been fueled by broad dollar weakness as markets fretted a debt squabble among lawmakers in Washington will result in the United States losing its top notch AAA credit rating.

A last-grasp deal to raise the U.S. borrowing limit that is expected to be finalized on Tuesday and avert a disastrous default, eased some pressure on the yen.

But Noda made plain the currency was still too strong for Tokyo's taste.

He said he was in discussions with the Bank of Japan and international partners about the yen's strength, which would hurt several sectors of the Japanese economy if it persisted.

Japan could intervene in the currency market anytime, said Masamichi Adachi, senior economist at JPMorgan Securities Japan. The authorities are likely waiting for a good time not in terms of yen's levels but such factors as market liquidity and changes in sentiment.

Because Finance Minister Noda is the prominent candidate for the next prime minister, he cannot afford to do nothing or request nothing of the BOJ, Adachi added.

A government official, speaking on condition of anonymity, told reporters that Tokyo had not yet decided whether to intervene.

BOJ ON STANDBY

Further policy loosening by the Bank of Japan would aim to amplify the impact of any intervention, sources familiar with the BOJ thinking said. The central bank is due to hold a regular policy review on August 4-5.

If there is intervention, there is a strong chance the BOJ will ease policy, said one source, who declined to be identified due to the sensitivity of the matter.

The BOJ would likely expand its 10 trillion-yen asset buying program by 5 trillion yen, which could also shore up business confidence, sources said.

Some currency strategists, however, doubted whether Tokyo would risk trying to turn a powerful tide.

It is difficult to envisage how intervention at the current juncture can prove effective as yen gains are not yet disorderly or excessive, said Lee Hardman, currency economist at Bank of Tokyo Mitsubishi in London.

Tokyo's run of verbal intervention may also hinder any potential currency intervention, said Tom Levinson, a currency strategist at ING in London.

FX intervention is most effective when its execution is a surprise. Intervention now would be anything but, given the raft of warnings, he said.

Japan last intervened in concert with the Group of Seven when expectations of fund repatriation after the earthquake pushed the yen to a record high.

This time, most market players believe Japan would have to go it alone since the yen's gains are more about dollar weakness than anything else.

Tokyo last acted solo in September 2010, when it sold 2.1 trillion yen.

It may seem ironic that Japan, saddled with public debt twice the size of its $5 trillion economy and faced with its biggest rebuilding effort since World War Two, would serve as a safe haven for risk-shy investors.

However, with the euro area mired in its own debt crisis, Japan's deep financial markets make it one of few viable options, market analysts say.

($1=76.615 yen)

(Writing by Tomasz Janowski; Editing by Nathan Layne and Kim Coghill)

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