Rumours that a large US hedge fund was unwinding yen positions also helped send the Japanese currency higher, traders said.
The yen gained as much as 3 per cent against both the dollar and the German mark after Japan's ruling Liberal Democratic Party (LDP) said it had agreed an alliance with the opposition Liberal Party. The LDP said it was considering income tax cuts worth more than 10 trillion yen (pounds 50bn) - more than double the amount announced earlier this week as part of the pounds 118bn rescue package.
The LDP also hinted at future cuts in the rate of sales tax. Many analysts believe that the decision to hike the sales tax in April 1997 helped to tip the economy into its worst recession since the Second World War.
Rebecca Patterson, currency analyst at JP Morgan, said: "The markets are getting excited about the possibility of a change in the tax regime, but I believe this optimism will fade away."
Separately, two of Japan's biggest lenders, Sanwa Bank and Daiwa Bank, said they were applying for 900 billion yen of public funds to shore up their heavy financial losses. Both banks said they would cut jobs and shut branches. Daiwa is to close its six overseas branches and will cut its workforce by 3 per cent. Sanwa is expected to shed around 700 jobs.Reuse content