TOKYO (Reuters) - Japan's Nikkei average surged 3.8 percent to close at its highest since October 2008, after the yen fell sharply on bets the early exit of the central bank governor opens the way for one who pursues aggressive monetary easing.
The benchmark packed on 416.83 points to 11,463.75, producing its biggest one-day gain since March 2011, as the Japanese currency hit a fresh low of 94.08 against the dollar.
Wednesday's Bank of Japan Governor Masaaki Shirakawa said he would step down, together with his two deputies, three weeks before the end of his five-year term in April.
Prime Minister Shinzo Abe has put the central bank under relentless pressure to do more to pull the economy out of the doldrums. He has made it clear that he wants a governor who will be bolder in loosening monetary policy.
"There was a very aggressive, solid weakening of the yen in response to what seems like relatively trivial news. But it's nonetheless news that signals the expectation and recognition that the momentum in Japan is continuing to favour yen weakening and risk-on mood," said Stefan Worrall, director of equity sales at Credit Suisse in Tokyo.
While investors have been gunning for exporters over the past 2-1/2 months as the yen has slid 15.5 percent against the dollar, Worrall said there were other benefits to a more competitive exchange rate.
"On a U.S. dollar basis Japan has yet to break out, particularly if you compare its rally with rallies in Germany, Australia, etc. A weakening yen should certainly see more than the dollar-yen translation into profits," he said.
On Wednesday, brighter profit forecasts from the likes of Toyota Motor Corp (7203.T) and Mitsubishi Heavy Machinery Ltd (7011.T) helped sustain the bullish mood. The hikes stemmed from the weaker yen, which inflates the value of earnings garnered overseas.
Toyota Motor Corp (7203.T) climbed 6.1 percent and was the most-traded stock by turnover on the main board, while Mitsubishi Heavy Industries (7011.T) soared 10.4 percent, with both stocks hitting their highest levels since autumn 2008.
Expectations of a new BOJ governor were also a boon for inflation-sensitive shares, as the central bank signed a new 2 percent inflation target last month with the government. On Wednesday, the real estate sector .IRLTY.T advanced 4 percent.
Norihiro Fujito, senior investment strategist at Mitsubishi UFJ Morgan Stanley, said the BOJ may start "open-ended" asset buying in April, well before the 2014 start the central bank committed to at its last policy meeting.
Fujito said he sees Kazumasa Iwata, a former BOJ deputy governor and a vocal supporter of a 50 trillion yen asset purchase fund, as the most likely candidate to succeed Shirakawa.
Others seen as possible candidates are Haruhiko Kuroda, president of the Asian Development Bank, and Heizo Takenaka, who a decade ago was an economics minister under Prime Minister Junichiro Koizumi.
If Takenaka is picked, "it could lift the market further because he is foreign investors' favourite," said Yasuo Sakuma, portfolio manager at Bayview Asset Management in Tokyo. "He is the one who helped the country's economy recover through aggressive restructuring under the Koizumi-led government, and foreign investors like that."
Foreign brokerages continued to make bullish reports on Japan. Societe Generale saying the country would emerge the winner if an Asian "currency war" were to erupt.
"The rest of Asia is more similar to Japan in the 1990s. Back then the currency was driven by capital flows; now the stock market is driven by export prospects," Societe Generale said. It noted that Japan was the only Asian nation in which a weaker currency led to higher stock market returns in the run-up to the 2008 crisis and in 2010-2012.
"If there is a currency war in Asia, with countries across the region trying to engineer their currencies lower, this could undermine stock markets - and backfire in terms of growth. Another good reason to prefer the Nikkei," the report said.
According to Thomson Reuters data, the most traded February Nikkei index options was a call at 11,750 JNI117B3.OS, 2.5 percent above where the index closed on Wednesday. The next most traded was another call with a strike price of 11,500 JNI115B3.OS, followed by a put at 11,000 JNI110N3.OS and another put at 11,250 JNI112N3.OS.
Additional reporting by Ayai Tomisawa; Editing by Richard Borsuk