BOJ to maintain ultra-low rates, sound warning over weak yen

By Leika Kihara

TOKYO (Reuters) - The Bank of Japan is likely to maintain ultra-low interest rates on Friday and stress its resolve to support a fragile economy with massive stimulus, a move that may further weaken the yen by highlighting a policy divergence with the rest of the world.

While a modest, technical tweak to its yield cap or guidance on the future policy path cannot be ruled out, the BOJ is seen sustaining its massive monetary support for now to ensure the economy is fully out of the doldrums.

Central banks across Europe raised interest rates on Thursday, some by amounts that shocked markets, in the wake of the U.S. Federal Reserve's 75-basis-point hike.

The likelihood that Japan will remain an outlier while global central banks tighten policy to combat inflation has pushed the yen down to 24-year lows, threatening to cool consumption by boosting already rising import costs.

But rising concerns over the weak yen have not deterred the BOJ from defending an implicit 0.25% cap for its 10-year bond yield target through ramped-up bond purchases.

At the two-day policy meeting ending on Friday, the BOJ is widely expected to maintain its -0.1% target for short-term rates and its pledge to guide the 10-year yield around 0%.

The central bank may also deepen its resolve to defend the 0.25% upper limit by targetting a wider range of debt maturities for its unlimited fixed-rate bond-buying operation, which currently covers only 10-year bonds, some analysts said.

"The BOJ could add a pledge to conduct emergency market operations targetting notes for a wider range of maturities," said Hiroshi Ugai, chief Japan economist at JPMorgan (NYSE:JPM) Securities.

"The central bank has no choice but to do this to control bond market moves, even though it probably doesn't want to accelerate the dollar's rises against the yen," he said.

The BOJ's yield cap has faced attack by investors betting the central bank could give in to global market forces, as rising U.S. yields push up long-term rates across the globe.

The BOJ is caught in a dilemma. With Japan's inflation well below that of Western economies, its focus is to support the stil-weak economy with low rates. But the dovish policy has triggered sharp yen falls, hurting an economy heavily reliant on fuel and raw material imports.

Some market players speculate the BOJ could raise its yield target or the implicit cap to slow the yen's decline.

BOJ Governor Haruhiko Kuroda has repeatedly stressed the need to keep interest rates ultra-loose, and that the central bank won't target exchange-rates in guiding policy.

Prime Minister Fumio Kishida appeared to defend Kuroda's stance. In a news conference on Wednesday, Kishida said the BOJ will likely take into account various factors besides yen moves, such as the impact on small firms' borrowing costs, in setting policy.

Kuroda is likely to warn against a weak yen at his post-meeting briefing, such as by highlighting the damage the currency's sharp falls could inflict on the economy, analysts said.