TOKYO: The Bank of Japan will probably cut its economic forecasts because of slowing global growth, but keep monetary policy unchanged next week unless this weekend's European debt crisis talks disappoint and trigger market upheaval.
Many Japanese central bankers are mindful of risks to the fragile economy with Europe's debt crisis keeping markets jittery and the global slowdown weighing on exports.
But with the IMF projecting 4 percent global growth this year and spending for reconstruction from the March earthquake and tsunami seen supporting domestic demand, the BoJ feels there is no hard evidence yet to suggest a sharp worsening of the outlook.
Further easing via more asset buying will become a possibility if weekend euro zone talks on the debt crisis triggers market turmoil. Otherwise, the BoJ hopes to stand pat for now, having just loosened monetary policy two months ago.
The BoJ will also issue new economic and price forecasts for the three years to March 2014 in a twice yearly outlook report, which serves as a basis for monetary policy decisions.
Here are possible outcomes:
POLICY ON HOLD, CUT GROWTH FORECASTS, BUT KEEP RECOVERY VIEW
POSSIBILITY: HIGHLY LIKELY
In the latest forecasts issued in July, the BoJ expected Japan's economy to expand 0.4 percent in the current fiscal year and 2.9 percent in the following year ending in March 2013.
It will cut these forecasts, aligning them more with private-sector projections. Analysts polled by Reuters expect 0.2 percent growth this fiscal year and a 2.2 percent increase the following year.
Such cuts will not be big enough for the BoJ to alter its view that Japan's economy is headed for a moderate recovery. A change in this scenario would warrant an immediate policy response, something the central bank is not willing to do yet.
Still, it will warn of risks from abroad, mainly Europe, and may signal that the timing of the recovery could have been delayed until well into next year from initial expectations of it happening as early as this autumn.
The BoJ will also project that core consumer inflation will be stuck around zero in fiscal 2011 ending next March and 2012 and stay well below the 1 percent threshold even as it picks up in fiscal 2013 -- signalling that interest rates will be kept ultra-low till then.
MARKET REACTION:
Stock prices may briefly fall on disappointment but any such moves will be short-lived. Markets will scrutinise Governor Masaaki Shirakawa's comments for clues on whether further easing remains a near-term possibility.
ABANDON RECOVERY VIEW, BOOST ASSET BUYING
POSSIBILITY: LESS LIKELY
The BoJ is clinging to its recovery forecast but is aware of growing risks. Japan is vulnerable if Europe's debt crisis hurts growth in emerging Asia -- Japan's key export market -- or triggers a global credit crunch.
It is ready act if the European Union's summit on Sunday disappoint markets so much that stocks will dive or the yen will rally on renewed safe haven buying. If market reaction is subdued, the BoJ hopes to save its limited policy options for later.
Any easing will probably take the form of a further expansion of the central bank's 15 trillion yen ($195 billion)asset buying scheme, under which it buys assets ranging from government bonds to private debt.
MARKET REACTION:
Bond yields and the yen might fall while share prices could rise, although the moves might not last long as markets have been anticipating a further increase in asset purchases at some point.
The BoJ regards the asset buying scheme as its key monetary policy tool. But it can probably only top it up once or twice more, given limits to the additional risk assets it can buy without hurting its balance sheet.
It is thus pondering alternatives. While the BoJ will not revert to old-style quantitative easing of targeting reserves parked at the central bank, it may consider buying government bonds more aggressively either by accepting debt with longer durations or significantly boosting the size of purchases.
This is not an immediate possibility but is rather an option that may emerge later this year or next year if Japan faces a severe economic downturn.
MARKET REACTION:
The surprise move would knock down bond yields and the yen.
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