BOJ to stick to recovery scenario despite tax hike impact

By Leika Kihara

TOKYO (Reuters) - The Bank of Japan is set to maintain its stimulus programme on Tuesday and its projection that inflation will approach its 2 percent target next year, unfazed by recent data casting doubts over its scenario of an investment-led economic recovery.

The central bank may slightly cut its economic growth projection for the current fiscal year to March 2015 as exports remain weak and household spending tumbled more than expected after a sales tax hike in April.

But the BOJ's nine-member board is likely to roughly maintain its optimistic inflation projections and stick to its view the world's third-largest economy will continue a moderate recovery as the pain from the tax hike subsides.

With no major changes in the broad economic outlook, the BOJ is set to maintain its policy framework, under which it has pledged to increase base money by 60-70 trillion yen ($592-$691 billion per year via aggressive asset purchases, largely of Japanese government bonds.

"There's a general sense that the tax hike impact will be limited. But when you look closely at hard data, the downturn in second-quarter GDP could be quite big," said Hideo Kumano, chief economist at Dai-ichi Life Research Institute.

"The focus will be on how much the BOJ will take this into account in coming up with new projections."

The BOJ has stood pat on policy since unleashing an intense burst of stimulus in April last year, when it pledged to pull Japan out of chronic deflation and accelerate consumer inflation to 2 percent in roughly two years.

BOJ Governor Haruhiko Kuroda has stressed that Japan is making steadily progress in hitting the price goal, and that the economy can ride out the sales tax hike as brighter economic prospects nudge companies into boosting wages and capital expenditure.

A recent slew of data has cast doubt on that scenario. Household spending and machinery orders, a leading indicator of capital spending, both tumbled in May, underscoring the fragile state of a recovery which so far has been driven by domestic demand as exports fail to pick up.

The BOJ may thus revise down its forecast that the economy will expand 1.1 percent in the current fiscal year, which is higher than a 0.9 percent rise forecast in a Reuters poll, sources familiar with its thinking said. [ID:nL4N0PK2FJ]

However, it is likely to roughly maintain its growth projections for fiscal 2015 and 2016, as well as its price forecasts that see consumer inflation hitting 1.9 percent in the next fiscal year and 2.1 percent the following year.

With any modification in the projections seen small, the BOJ expect any market reaction to be muted.

Many BOJ officials also see little reason to alter their view the economy will rebound after an expected contraction in the second quarter, pointing to upbeat capital spending plans in the central bank's "tankan" survey and a low jobless rate that is seen gradually leading to higher wages.

But such optimism has failed to shake off doubts held by private-sector analysts that consumer inflation will accelerate as quickly as the BOJ projects.

Core consumer inflation hit 1.4 percent in the year to May, excluding the effect of the sales tax hike, but is seen slowing in coming months as the boost from a weak yen -- which inflates import costs -- fades.

Kuroda has said consumer inflation may slow to levels just above 1 percent in coming months before accelerating again, stressing that several months of soft price data would be of little surprise and therefore won't serve as a reason to ease policy again.

With scepticism over the BOJ's price projections running high, the governor may reiterate the view at his post-meeting news conference, analysts said.

The BOJ issues its long-term economic and price projections in a semi-annual outlook report in April and October of each year, and reviews them in January and July. They are all conducted on the day of its policy-setting meetings.

($1 = 101.3500 Japanese Yen)

(Editing by Kim Coghill)