* Lack of Japan policy action on yen weighs on Nikkei
* Nikkei's next target at 8,697, 61.8% retracement
* Nikkei slow stochastic, RSI both oversold
* 9,000-level could become strong resistance-analyst
By Elaine Lies and Aiko Hayashi
TOKYO, Aug 25 (Reuters) - The Nikkei average hit a 16-month closing low on Wednesday, at one point falling over 2 percent, as disappointment spread over the lack of policy action by Japan to rein in the strong yen, which threatens a fragile economic recovery.
Hopes for action by the government and the Bank of Japan on the yen, which rose to a 15-year high on Tuesday, had provided early support after the Nikkei business daily reported that the Ministry of Finance may consider unilateral yen-selling market intervention if speculators drive up the yen.
But these hopes gradually faded as the day wore on without signs of any new policy moves, while a raft of statements by Finance Minister Yoshihiko Noda had little impact.
Noda, who met with Prime Minister Naoto Kan and Chief Cabinet Secretary Yoshito Sengoku, said he had not received any specific instructions from Kan on currency issues, adding that he could not comment on the chance of Japan intervening in forex markets.
The Nikkei pared losses slightly in late trade, though, after government sources said Japan was not ruling out forex intervention as a policy option.
"There have been a lot of reports hinting that something might happen with the BOJ, and a lot of statements, but the growing market feeling is 'just do it'," said Koichi Ogawa, chief portfolio manager at Daiwa SB Investments.
"The consensus is that solo intervention might not have much of an impact, but investors keep on expecting something -- and all we have is talk."
The benchmark Nikkei shed 1.7 percent to 8,845.39, its lowest close since late April 2009, though still well above the 26-year closing low just over 7,000 hit in March 2009. The broader Topix lost 1.3 percent to 807.31.
The Nikkei has lost some 3.6 percent so far this week.
The dollar recouped some ground to 84.34 on electronic trading platform EBS after hitting a 15-year low of 83.58 yen the day before.
Market players said the longer it took for the Nikkei to recover above 9,000, which long served as a key support level, the gloomier the outlook was likely to be.
The benchmark Nikkei broke below 9,000 on Tuesday for the first time since May 2009. The 9,000 to 9,100 area had been strong support since last year, and market players said there were few technical targets to break the benchmark's fall.
"That the Nikkei has broken below 9,000, which has been very strong support for a while, is a significant event and it's urgent that Japanese authorities take action," said Koichi Nosaka, a market analyst at Securities Japan Inc.
"If the index stays below that level for too long, 9,000 will eventually become solid resistance."
Some market players said speculative selling of Nikkei futures helped drive the benchmark lower, and while there was talk of buying at the lows by pension funds it was difficult to confirm.
By some technical measures, the Nikkei is also starting to look oversold and perhaps due for a bit of a rebound.
Its relative strength index (RSI) fell to 32, with 30 and under considered oversold, while its slow stochastic fell deeper into oversold territory. The Nikkei also fell through its lower Bollinger Band.
GROWING PESSIMISM
Still, pessimism about global growth has become contagious in recent weeks after lacklustre U.S. employment and consumer reports. Fears were reinforced on Tuesday by a report showing U.S. existing house sales slid much more than expected in July after the government ended homebuyer tax credits.
"There are also a lot of important indicators coming up, and bad numbers could increase the chance of the Federal Reserve taking some kind of policy steps," said Nagayuki Yamagishi, a strategist at Mitsubishi UFJ Morgan Stanley Securities.
Honda Motor Co and other exporters slid.
Many Japanese exporters have set their currency rate assumptions around 90 yen per dollar for the financial year to next March, although Honda cut its assumption to 87 yen from 90 yen. A stronger yen eats into exporter profits when repatriated.
Honda lost 3.1 percent to 2,718 yen, TDK Corp shed 3.2 percent to 4,240 yen and stepper maker Nikon Corp fell 2.6 percent to 1,372 yen.
Among other notable stocks, Nippon Sheet Glass sank 5 percent to 189 yen after it said it would sell up to 49 billion yen ($576 million) of new shares to raise funds to ramp up output of glass for emerging economies.
The offering will boost the number of shares outstanding by 35 percent.
Trade picked up, with some 1.78 billion shares changing hands on the Tokyo exchange's first section, its highest volume in about two weeks.
Declining stocks outnumbered advancing ones by nearly 3 to 1. (Editing by Michael Watson)