Moody's Investors Service Inc. said Wednesday it will review for possible downgrade the Aa3 rating of yen-denominated domestic securities issued or guaranteed by the Japanese government.

The U.S. credit-rating agency said the range of possible outcomes of the review consists of confirming the Aa3 rating or lowering it by one or two notches.

But Japan's Aa1 foreign currency debt rating and Aa1 rating for internationally issued bonds will be unaffected by the action and have stable outlooks, Moody's said.

If downgraded, the government's domestic bond rating would fall below that of Italy, which also stands at Aa3, making it the lowest among the Group of Seven industrialized nations. Moody's last downgraded Japan's domestic bond rating on Dec. 4.

Chief Cabinet Secretary Yasuo Fukuda, the top government spokesman, tried to dismiss Moody's announcement.

"Moody's is a private ratings agency," he said. "So, it is up to itself" to make such judgments about the Japanese economy. "But I must say it does not know Japan's real power."

Fukuda also said Moody's appears to have made the judgment based on the belief that deflation will continue to haunt the Japanese economy.

The agency said its decision to review the government's bond rating was prompted by deflation.

"Deflation is the foremost challenge facing Japanese authorities, exacerbating overall credit risks throughout the economy as debt rises in real terms," the agency said.

"The longer it takes for the government to fashion an effective policy response to deflation, the more complicated solving other economic problems becomes."

The credit agency said the review will focus on assessing the range of possible outcomes for government policies and reform initiatives.

Moody's noted Japan has considerable strengths, including a strong external position and a large pool of domestic savings, mitigating risks to the Aa1 foreign currency ratings.

But it also said it believes there could be a "credit risk contagion" between domestic and foreign financial markets if Japan's economy and fiscal performance were to crumble further.

"If the fiscal and economic situation deteriorates at the pace similar to that witnessed in recent years, given the large existing public-sector debt, the pace of ratings transition might need to be accelerated," Moody's said.

Meanwhile, ruling Liberal Democratic Party Secretary General Taku Yamasaki said he believes Japan's credit ratings are unlikely to be downgraded further as Tokyo will strive to push through fiscal reforms to reduce its dependency on borrowings.

"We are about to devise an economic package that will ensure the government's pledge to keep the nation from sliding into a deflationary spiral," Yamasaki told foreign journalists.

Moody's said later it will also review for possible downgrades the domestic currency credit ratings of seven Japanese fiscal investment and loan program agencies, including Japan Highway Public Corp.

The move is in line with Moody's plan to review for possible downgrade the Aa3-rated yen-denominated domestic securities issued or guaranteed by the Japanese government, the U.S. credit-rating agency said.

Moody's identified the six other public corporations as Hanshin Expressway Public Corp., Development Bank of Japan, Japan Bank for International Cooperation, Japan Finance Corp. for Small Business, Japan Finance Corp. for Mutual Enterprises and Shoko Chukin Bank.

Foreign players lead

Foreign players led dollar buying after Moody's Investors Service Inc. said on Wednesday it is reviewing its Japanese government bond rating for a possible downgrade.

Hitoshi Imamura, a foreign exchange manger at Aozora Bank, said foreign players started position-adjusting dollar purchases on the news.

"Foreign players reacted to the strong language that the rating could be downgraded by two notches," Imamura said. "But Japanese players did not react to it" because it was expected.

The dollar regained the 133 yen level in Tokyo on Wednesday after a weak start in the morning.

Minori Takeuchi, a senior foreign exchange market analyst at JP Morgan Chase Bank, agreed foreign players reacted more to the news, since the downgrade review was widely expected in Tokyo.

"One factor that is different from previous moves of the sort is the fact that if it is really carried out, (the rating) could be cut to a single-A level."

But another analyst said the review news had a limited effect.

"Japanese stocks are holding firm, and it will not have a big enough impact to trigger a triple decline in the prices of the yen, bonds and stocks," said Ryohei Muramatsu, Commerzbank foreign exchange manager.

The 225-issue Nikkei stock average rose for a fourth straight day Wednesday.