By Leika Kihara and Tetsushi Kajimoto
TOKYO (Reuters) - Japan will push back firmly on any attempts by U.S. President Donald Trump's administration to meddle with its independence on setting currency and monetary policies, say sources familiar with the deliberations in Tokyo.
It was the first clear sign from Japan that Tokyo won't allow Trump to dictate domestic economic policy, leaving room for potential tensions between the staunch allies as Trump's first term gets underway.
Policymakers were shocked by an accusation from Trump this week that Tokyo is using "money supply" for currency devaluation, a sign his criticism could distract the BOJ from its years-long efforts to revitalize the economy.
Any explicit pressure from Trump that binds Japan's hands on monetary policy would challenge existing international protocols like a Group of 20 agreement, which broadly recognizes that domestic polices are a matter for individual members.
Ahead of Prime Minister Shinzo Abe's meeting with Trump next week, Japanese policymakers are preparing to argue that their ultra-loose monetary policy is intended solely to beat deflation and was not currency manipulation, the sources said on condition of anonymity.
And if persuasion alone does not work, they will seek to coordinate with Japan's G7 and G20 counterparts for support that they are abiding by a joint agreement to refrain from using monetary policy for currency devaluation, the sources said.
"Japan and Europe will continue to promote independence of monetary policy," said a government official with knowledge of the matter, adding that U.S. criticism "won't tie our hands."
"There's no reason for the United States to criticize our currency and monetary policies."
The BOJ's stimulus program and the weak yen it brought have been one of the few successes of Abe's "Abenomics" policies, a cocktail of monetary stimulus, fiscal expansion and structural reforms, which have yet to pull Japan out of deflation.
For the BOJ, the worst-case scenario is for Trump's remarks to heighten market speculation that the central bank won't be able to ease further because of U.S. pressure - and for such market views to spark a self-fulfilling jump in the yen.
"Trump's rhetoric is dangerous for Japan," said a source familiar with Japan's currency policy.
"If monetary easing is automatically defined as currency manipulation, what can Japan do? If Trump doesn't want a strong dollar, the Federal Reserve would have to hold off on hiking interest rates. It opens up a can of worms."
BOJ officials say they see good reason to push back, arguing that the yen's recent falls are part of a broader dollar rise driven by expectations of steady Fed rate hikes.
With Japan's economy only just emerging from stagnation, policymakers are ready to defend the BOJ's massive stimulus and its independence to use tools to fend off adverse shocks to the economy such as an abrupt yen spike, the sources say.
"Anything Trump says won't be a hindrance to monetary easing, if such action is necessary to achieve 2 percent inflation," one of the sources said on condition of anonymity.
Japan is putting together a package for Abe to show Trump next week that it says would help create U.S. jobs, government sources say, but Tokyo would still resist anything that it sees as meddling in domestic policy.
TRUMP RISKS
Trump's U.S. election victory in November initially brought benefits to Japan as dollar gains fueled by hopes for his stimulus policies weakened the yen in a boon to its exports.
But his recent remarks turned him into one of the biggest risks to Japan's economy, with the dollar hitting a two-month low of 112.08 yen this week.
Already, Trump has ruffled "Abenomics" with his demand for Japanese carmakers to create more U.S. jobs, potentially forcing them to hold off on domestic wage hikes.
He also hammered the final nail in the coffin on the Trans-Pacific Partnership (TPP) pact by pulling out from the deal, to the dismay of Abe who touted it as key to his growth strategy.
Abe told parliament on Thursday he had no intention of making deals with Trump on currency policy, though some analysts say Trump's unorthodox governing style may pressure Japan.
"I can't see how Japan can convince Trump that its monetary policy is not targeting currencies," said Masafumi Yamamoto, chief forex strategist at Mizuho Securities.
"Monetary policy will come under U.S. pressure, making it difficult for the BOJ to ease policy further to weaken the yen."