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BOJ to hold fire, tone up optimism on economy

A woman walks past the Bank of Japan building in Tokyo
A woman walks past the Bank of Japan building in Tokyo

By Leika Kihara

TOKYO (Reuters) - The Bank of Japan is expected to hold off on easing monetary policy further and revise up its assessment of the economy next week, encouraged by a pickup in factory output and recovery in business sentiment hit by the devastating earthquake in March.

But the central bank will likely warn of lingering risks to the global economy, which is showing increasing signs of slowdown just when Japan is overcoming supply constraints.

Unless a sudden, renewed spike in the yen threatens Japan's recovery prospects, the central bank is set to stand pat on policy and maintain interest rates at a range of zero to 0.1 percent.

It will also review its GDP and price forecasts for the current and following fiscal years in a quarterly revision of its long-term projections.

Here are possible outcomes from the meeting:

STAND PAT ON POLICY, UPGRADE ECONOMIC VIEW POSSIBILITY: HIGHLY LIKELY

The central bank is growing increasingly confident that Japan's economy will resume a moderate recovery in autumn as companies restore supply chains faster than expected and factory output is seen returning to pre-quake levels in August.

In the latest sign of improvement, a Japanese newspaper reported on Wednesday that the country's top carmaker Toyota Motor Corp <7203.T> would return to full production in October, one month ahead of schedule.

It will thus revise up its assessment from last month, when it said the economy appeared to be picking up but remained under downward pressure mainly on output. That will reinforce market expectations that no immediate easing is in the horizon.

The BOJ is expected to cut its economic forecast for the current fiscal year that began in April from the 0.6 percent growth projected three months ago. The new estimate is seen roughly in line with a Reuters poll of a 0.3 percent expansion.

But this would be a technical revision reflecting the steep contraction in January-March GDP and revisions to last year's figures, and would not affect monetary policy nor the central bank's view that growth will pick up toward the end of this year.

The BOJ may slightly revise up its economic forecast for the following fiscal year from a 2.9 percent expansion projected in April, although any change will likely be minor.

MARKET REACTION: Markets will not react much as analysts generally share the BOJ's upbeat view on the economy.

KEEP ECONOMIC VIEW STEADY, WARN OF GLOBAL SLOWDOWN POSSIBILITY: LIKELY

Supply constraints are easing faster than forecast but the BOJ is hardly optimistic about the long-term outlook. Some in the central bank have become increasingly worried about softening global growth which, if prolonged, will hurt exports just when Japan emerges from supply constraints in autumn.

Governor Masaaaki Shirakawa said on Monday the global economy continues to recover albeit at a slower pace, taking a slightly more cautious view on global growth as signs of a slowdown spread to emerging economies.

Many in the central bank still do not expect the global slowdown to turn into a recession that would hurt exports severely enough to threaten Japan's recovery.

But the BOJ may issue a stronger warning on heightening risks to the global economy. Some may be worried enough to argue against upgrading the assessment of Japan's economy.

MARKET REACTION: Bond yields and the yen may fall if the BOJ's warning is strong enough to heighten expectations of an imminent monetary easing, although this is highly unlikely.

EASE MONETARY POLICY FURTHER POSSIBILITY: HIGHLY UNLIKELY

The central bank is aware of various risks that may hurt Japan's recovery prospects. The global slowdown may weigh on exports down the road, while a prolonged nuclear plant shutdown would boost costs for Japanese companies and may prompt them to further shift production overseas.

All these risks, however, are not imminent enough for the central bank to ponder loosening policy now.

Some in the BOJ saw the Greek debt crisis as a most likely trigger for easing if it destabilized markets and hit Japanese business sentiment.

But with Greece having overcome immediate funding problems and the yen well off historical highs against the dollar, the BOJ sees no reason to use its limited policy options now.

MARKET REACTION: The surprise move will knock down bond yields and the yen, although the impact will be short-lived.

(Editing by Tomasz Janowski)

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