By Leika Kihara and Takahiko Wada
TOKYO (Reuters) -The Bank of Japan is leaning towards keeping its yield control policy unchanged at next week's meeting, five sources familiar with its thinking said, as policymakers prefer to scrutinise more data to ensure wages and inflation keep rising.
But there is no consensus within the central bank on how soon it should start phasing out stimulus, which could make next week's decision a close call.
With inflation having exceeded the BOJ's target for more than a year, markets have been simmering with speculation the central bank could tweak yield curve control (YCC) as early as the July 27-28 meeting.
Some market players bet the central bank could widen the allowance band set around its yield target to arrest market distortions caused by its heavy bond buying.
With the 10-year yield moving stably below the 0.5% yield cap, however, many BOJ policymakers see no imminent need to take fresh steps against the side-effects of YCC, the sources said.
They also believe the BOJ can afford to wait until there is more clarity on whether the global economy can avert a hard landing and allow Japanese firms to earn enough profits to keep hiking wages next year, they said.
Notwithstanding abrupt moves in the bonds and yen, the BOJ is likely to make no changes to its policy framework next week, they said.
"Inflation is accelerating more than expected. But the key is whether the increase is sustainable, which will depend largely on corporate profits and next year's wage outlook," one of the sources said.
"YCC needs to end at some point. But the timing is probably not now," said another source. "There are signs of change in Japan's deflationary mindset. But it's still sentiment-driven rather than something substantial."
Even if the BOJ were to make tweaks, it would likely be a minor fine-tuning to make YCC sustainable, a third source said.
BROADER INFLATION OUTLOOK UNCHANGED
In fresh quarterly projections due after the meeting, the board is likely to revise up its core consumer inflation forecast for the year that began in April, the sources said.
But the forecasts for fiscal 2024 and 2025 will likely remain largely unchanged from current projections, they said.
Under current forecasts made in April, the BOJ expects core consumer inflation to hit 1.8% this fiscal year and accelerate to 2.0% next year, before slowing to 1.6% in 2025.
It expects core-core inflation, which strips away the effect of volatile fresh food and energy, to hit 2.5% this year, 1.7% the following year and 1.8% in 2025.
Under YCC, the BOJ guides short-term interest rates at -0.1% and the 10-year bond yield around 0% as part of efforts to reflate growth and sustainably achieve its 2% inflation target.
The bank also sets an allowance band around the 10-year yield target, which was widened last December to 50 basis points up and down the 0% target as part of efforts to fix market distortions caused by its huge bond buying to defend the cap.
While a hike in short-term rates remains distant, a decision on whether to make tweaks to the yield band would depend on the balance between the benefits and cost of YCC, the sources said.
Markets have whip-sawed on mixed views on how soon the BOJ could tweak YCC. BOJ Deputy Governor Shinichi Uchida's remarks earlier this month that the central bank was mindful of the side-effects of the policy also led some market players to bet it could raise the 0.5% ceiling set for the 10-year bond yield.
But market expectations of a July tweak subsided after Governor Kazuo Ueda's remarks on Tuesday suggesting that the threshold for dialing back stimulus remains fairly high.
"We expect the BOJ will keep major policy levers unchanged next week," said Stefan Angrick, senior economist at Moody's (NYSE:MCO) Analytics. "Regardless of whether the BOJ adjusts YCC or not, a broader lift-off in rates remains distant."
More than three-quarters of economists polled by Reuters said they expect the BOJ to keep policy steady including its yield control scheme next week.