BOJ set to hold fire, seek to dispel tapering fears

By Leika Kihara

TOKYO (Reuters) - The Bank of Japan is set to maintain its massive monetary stimulus on Tuesday and reassure markets any reversal of its ultra-loose policies is some time off, as recent global bond yield gains test its policy of controlling the yield curve.

Markets are also focusing on what BOJ Governor Haruhiko Kuroda has to say on U.S. President Donald Trump's protectionist trade stance, particularly with Trump taking direct aim at Japan's powerful auto industry - a mainstay of its economy.

"It would be very problematic if protectionism spreads, but I don't think that will happen," Kuroda said earlier this month in Davos, Switzerland, pointing to strong commitments G7 and G20 nations have made to promoting global trade.

At a two-day rate review ending on Tuesday, the BOJ is set to maintain a pledge to guide short-term rates at minus 0.1 percent and the 10-year bond yield to around zero percent.

Global bond yields have risen on expectations that Trump's pledge of big infrastructure spending could lead to higher U.S. inflation, putting upward pressure on Japanese long-term rates.

Japanese government bond yields spiked last week after the BOJ skipped a much-anticipated auction to buy short-term debt on Wednesday, stoking fears it may taper its asset-buying programme earlier than expected.

At his post-meeting briefing, Kuroda will likely seek to allay such concerns by stressing the BOJ's resolve to maintain its ultra-easy policies until inflation exceeds 2 percent.

NEW CHALLENGES

The BOJ will also conduct a quarterly review of its growth and price forecasts at the meeting. Its nine-member board is likely to raise its growth estimates for the coming years, as exports rebound on brightening prospects for the global economy.

But the central bank is likely to make only minor, if any, upward revisions to its already optimistic inflation forecasts despite external headwinds that push up prices, such as a rebound in oil prices and rising import bills from a weak yen.

With domestic demand still weak, many central bankers remain wary on whether price rises driven by external factors could transform into sustained price growth.

Japan's growth remained anaemic in the first half of last year as consumption slumped. But a pick-up in global demand has helped exports recover, giving rise to market bets the BOJ's next move may be to hike - not cut - rates.

The BOJ was forced to revamp its policy last September into one targeting interest rates, rather than the pace of its money printing, after more than three years of aggressive bond buying failed to accelerate inflation to its 2 percent target.

But the new framework, dubbed "yield curve control" (YCC), has brought new challenges. With markets accustomed to huge bond buying by the BOJ, any sign of slowdown in its purchases has prompted market speculation it could withdraw stimulus.

The central bank's task has been made more difficult by a loose commitment it will continue to buy Japanese government bonds (JGB) at the current volume, so that the balance of its holdings increases at 80 trillion yen ($699 billion) per year.

The BOJ was on course to buy the smallest amount of JGBs in more than two years in January, fanning suspicions it might gradually reduce its purchases. It will release details of its bond buying plans for February on Tuesday.

"After the BOJ meeting...JGB market participants are focusing on the BOJ's JGB purchase plan for the month of February, rather than its policy statement," said Naomi Muguruma, senior strategist, Mitsubishi UFJ Morgan Stanley Securities.

($1 = 114.4100 yen)

(Reporting by Leika Kihara; Editing by Eric Meijer)