The Bank of Japan may sound less pessimistic about the economy on Tuesday but it will likely keep its bias skewed towards further monetary easing, with the finance minister pressuring it again to do its utmost to fight deflation.
But it remains ready to ease monetary conditions in the future, such as by buying more government debt or expanding on the new funding operation, if sharp yen or bond yield gains threaten an economy barely out of deep recession.
In a sign the government will maintain its pressure on the BOJ, Finance Minister Naoto Kan told parliament on Tuesday he wanted to overcome deflation by working with the central bank.
“Deflation continues to plague the economy and if the yen shoots up again, the BOJ may expand its new funding operation as early as next month,” said Kyohei Morita, chief Japan economist at Barclays Capital.
The central bank is almost certain to keep its policy rate at 0.1 percent and hold off on new policy initiatives after its two-day rate review, having staved off government pressure in December by starting a new funding operation.
BOJ officials have become more confident that Japan will avoid another recession, given stronger-than-expected growth in Asia and receding pessimism over the US economy.
Confidence among Japanese manufacturers has recovered to its highest level since the financial crisis and strong exports to Asia have raised hopes of a global recovery, a Reuters survey showed on Monday.
But with the government still worried about the risk of a return to recession in the run-up to upper house elections expected in the summer, the BOJ may warn of downside risks to growth, such as weakness in capital spending, and reassure markets that it will stick to its ultra-easy monetary policy.
The government criticised the BOJ for being too rosy on the economy when the bank upgraded its assessment in November. That eventually led the BOJ to cave in to pressure and adopt last month a new fund supply operation at which it offers 10trn yen ($111bn) in three-months loans to banks at 0.1 percent. It then declared that it wouldn't tolerate deflation.
Yen borrowing costs have since fallen and pulled the yen off a 14-year high against the dollar hit in November.
Three-month LIBOR rates have fallen below 0.26 percent from around 0.29 percent before the December 1 decision.
The BOJ has been virtually alone in expanding its monetary easing. The Federal Reserve and the ECB have said they will start phasing out their emergency lending and liquidity facilities in light of improvements in credit markets.
Japan has a deep-rooted problem with falling prices, and the BOJ looks likely on Tuesday to stick to its prediction that deflation will persist for three years, with price falls expected to moderate over that time.
In a review of the long-term growth and price forecasts it issued in October, the BOJ board is also likely to conclude that the economy is on track for a moderate recovery early next year.
The government, now partly preoccupied by a funding scandal, has toned down its criticism of the BOJ since the bank declared Japan was in deflation. Kan, one of the most vocal cabinet critics of the bank, said last Friday the government shouldn't meddle in monetary policy affairs.
But on Tuesday he reminded the BOJ that the government would need its help to get out of deflation, saying that there are still various monetary policy options the BOJ could take.
Kan is also expected urge the BOJ to support the economy through flexible policy in a speech he will give in parliament on Friday, the Nikkei newspaper reported.
Analysts don't expect the BOJ to respond immediately with another emergency meeting. But some say government pressure, coupled with a weakening economy, may nudge the bank into easing again later this year.
Japan isn't alone in experiencing friction between the central bank and the government. The US Senate looks likely to approve Federal Reserve Chairman Ben Bernanke to a second term only grudgingly as the Fed has become a target of public outrage, with the US jobless rate stubbornly high even as Wall Street profits and bonuses have soared.
With little room to cut already low rates, the BOJ hopes to keep its policy gunpowder dry for when the economy falters and government pressure on the bank heightens again.
The central bank has pledged to keep rates near zero until prices start rising again, so most in the market don't expect any hikes until early 2012.