TOKYO: Europe's debt crisis will keep the Bank of Japan edgy as its board meets next week, but the central bank is expected to keep monetary policy on hold unless a turn of events unleash a shock market reaction that threatens Japan's recovery prospects.
Slowing global growth and persistent rises in the yen have weighed on exports and factory output, casting doubt on the central bank's view that the Japanese economy is headed for a moderate recovery toward the end of this year.
But many in the BOJ feel that risks to growth have not heightened enough to loosen policy again, having just eased in August to pre-empt any damage to the economy from the global slowdown and the strong yen.
Still, the decision will be a close call with board members seen scrutinising developments in Europe until the last minute. The BOJ may choose to ease again if jitters over Europe's debt crisis trigger a renewed yen spike and stock price falls which are deep enough to derail a recovery from the March earthquake.
Here are possible outcomes from the two-day meeting:
STAND PAT ON POLICY
POSSIBILITY: HIGHLY LIKELY
The BOJ has become less convinced about Japan's recovery prospects as export and output growth wanes. But it is clinging to the forecast for now, hoping demand from emerging nations will keep exports afloat and car makers will continue to ramp up output to make up for disruptions caused by the quake.
Having eased policy by boosting asset purchases in August, it feels it has forestalled risks enough to wait for clearer evidence that global growth is slowing more than expected and hurting corporate profits, not just sentiment.
Even if it were inclined to ease, the BOJ wants to wait until another rate review on Oct. 27, when it issues new forecasts for growth until the year to March 2014. A major overhaul of its economic projections would give it justification to ease again if needed.
Most of all, the BOJ wants to save its depleted policy arsenal for now with plenty of factors that could threaten Japan's recovery in coming months.
The yen is somewhat off its record high but could renew its spike any time. Political pressure for action by Japan's central bank may also heighten, as the government faces staunch opposition from lawmakers for its plan to raise tax to foot the bill for post-quake reconstruction.
MARKET REACTION:
Markets may not react much to the decision but will scrutinise the BOJ's post-decision statement and Governor Masaaki Shirakawa's news conference for any clues on whether the bank will ease on Oct. 27.
EASE POLICY BY BOOSTING ASSET PURCHASES
POSSIBILITY: LESS LIKELY
The BOJ is determined to quickly counter any adverse market moves that threaten the economy. That means it may loosen policy if Europe fails to avert a disaster in its debt crisis and causes severe market turmoil.
Even if market moves are not too extreme, some in the board are more pessimistic about the economic outlook than others, and thus more willing to ease sooner rather than later. Ryuzo Miyao, for one, has said that Japan's economy may get less support than expected from overseas demand as Europe's debt woes escalate.
Pessimists in the board may get their way if fears of a global recession heighten and further threaten the BOJ's view that global demand will remain firm.
A worse-than-expected reading in the BOJ's tankan quarterly business sentiment survey, due out on Monday, or a surprise rate cut by the European Central Bank, which meets on Thursday, may nudge the board more in favour of loosening policy.
If the BOJ were to ease policy it would likely boost its asset buying scheme -- which was topped up in August -- by another 5 trillion yen ($65 billion) with most of the increase going to government bonds and exchange-traded funds.
MARKET REACTION:
Bond yields and the yen may fall while share prices may rise, although the impact would be short-lived if global markets remain under pressure.
POSSIBILITY: UNLIKELY
The central bank regards the asset buying scheme, targeting government bonds and a range of private debt, as its key monetary policy tool. But it can probably only top it up once or twice more, given limits to how much more 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 if Japan experiences a severe economic downturn.
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