Moody's Investors Service warned Japan that ineffective currency intervention would be negative for its sovereign ratings and would not help it restore its finances, even as G7 policymakers tried to show solidarity against market turmoil sparked by U.S. and European debt woes.

The warning was a shot across the bow for Japan, saddled with public debt double the size of its $5 trillion economy, just days after the United States lost its top-tier AAA credit rating from Standard & Poor's.

Finance Minister Yoshihiko Noda on Monday signaled Tokyo's readiness to continue intervening in the currency market to stem yen rises, citing a Group of Seven agreement to jointly counter any excessive and disorderly exchange-rate moves.

Moody's, however, said that while Japan's solo currency intervention and monetary easing last week initially pushed the yen lower against the dollar, the effect proved short-lived and was a negative for the economy and its credit rating.

Yen strength has eroded the competitiveness of Japan's exports and hampered the economy's ability to sustain its recovery from the 2009 global recession, Moody's said.

Currency and monetary policy action alone will not solve the bigger problems plaguing Japan, such as the huge cost for reconstruction from the quake and the nuclear plant disaster, as well as much-needed social welfare reforms to restore the country's fiscal health, Moody's said in a statement on Monday.

Major ratings agencies have all put Japan's sovereign rating on negative outlook as the country struggles to balance the need to support its economy, hit by a deadly earthquake in March, and to fix its public finances, which are the worst among G7 economies.

BOJ REMAINS ON ALERT

Moody's announcement came hours after G7 finance leaders signaled their readiness to take coordinated action against excessive and disorderly currency moves.

A G7 telephone conference was arranged after worries of another U.S. recession and concern about the euro zone debt crisis hit global stocks and pushed the yen up near record highs, as investors sought the currency as a safe haven.

The yen's spike prompted Japan to sell 4.6 trillion yen ($59 billion) in the currency market last week and the BOJ to ease monetary policy to alleviate the pain to the export-reliant economy.

But the moves have failed to push the dollar sustainably above 80 yen -- the rate on which many manufacturers have based their earnings forecasts for the current fiscal year. It stood around 77.80 yen on Monday.

We will continue to carefully monitor market moves. We also confirmed the G7 stance on currencies, Noda told reporters after Monday's emergency G7 phone meeting.

He did not comment on whether they discussed the possibility of joint currency intervention to support the dollar, but said Japan asked its G7 counterparts for their statement to make a clear mention of issues related to the currency market.

Japan's central bank refrained from draining funds that entered the market through last week's yen-selling intervention, thereby amplifying the effect of intervention and monetary easing.

The BOJ is ready to pump huge amounts of liquidity into the banking system on any signs of stress in the money markets, a central bank source told Reuters.

Despite Moody's warnings, Japan may not have much choice but to rely on currency intervention and monetary easing to support its fragile economy.

Having just acted last week, the BOJ hopes to hold off on additional easing for now to save its limited policy options for when the economy faces bigger troubles.

But BOJ officials do not rule out easing policy further in the near term and are keeping an eye on a U.S. rate-setting meeting on Tuesday, which may trigger sharp yen rises against the dollar if the Federal Reserve signals additional monetary stimulus.

Noda expressed hopes that the BOJ will continue to support the economy with its ultra-loose monetary policy.

He also said market trust in the dollar and U.S. Treasuries had not wavered in the wake of S&P's downgrade, indicating that Tokyo will maintain its huge holdings of U.S. government bonds.

Japan held $912 billion in U.S. Treasuries as of May 2011, second only to China's $1.16 trillion in holdings, according to the U.S. Treasury Department.

Moody's changed its outlook on Japan's Aa2 rating to negative from stable in February on concern that economic and fiscal policies would fall short of the tax reform needed to achieve deficit reduction targets and curb a rise in debt.

($1 = 78.490 Japanese Yen)

(Additional reporting by Rie Ishiguro, Tetsushi Kajimoto and Kaori Kaneko; Editing by Nathan Layne and Edmund Klamann)

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