By Leika Kihara and Takahiko Wada
TOKYO (Reuters) - The Bank of Japan (BOJ) may need to adjust its ultra-easy policy if inflation keeps exceeding its forecast, such as by replacing its yield cap with a looser reference range for long-term interest rates, a former central bank executive said on Wednesday.
The BOJ will not adjust its interest rate targets at next month's policy review, said Hiromi Yamaoka, a former BOJ executive who retains close contact with incumbent policymakers. But the central bank could be forced to do so within a year as inflation widens from the narrow range of mostly imported products where it is now most evident, Yamaoka told Reuters.
"There are various unconventional monetary policies, but the BOJ's yield cap is among the hardest to exit," said Yamaoka, who has experience overseeing the BOJ's market operations.
"The BOJ must brain-storm policy ideas in case inflation overshoots its forecast," because central banks lose credibility if the public sees they lack control over inflation, he said.
The BOJ targets a 10-year bond yield of 0%, with a cap of 0.25%, under a policy called yield curve control (YCC), making it an outlier as central banks elsewhere hike interest rates to fight rising inflation.
Taking a view that recent inflation rates will be temporary, BOJ Governor Haruhiko Kuroda has brushed aside the chance of adjusting YCC.
The BOJ most recently forecast, in April, that consumer prices in the fiscal year to March 2023 would be 1.9% higher than in fiscal 2022. A Reuters poll of economists predicted a 2.1% rise.
Yamaoka said there was a good chance inflation would exceed the BOJ's forecast, which assumes price growth will slow sharply later this year.
In May, consumer prices were 2.1% higher than a year earlier, compared with a 0.2% annual rate seen in January. The acceleration has been driven especially by fuel and commodity costs.
If inflation continues to move up, the BOJ must find the least disruptive way to phase out YCC, Yamaoka said. One idea would be to replace its 0% yield target with a looser reference range and pledge to intervene if rates spiked too much, he said.
"The BOJ also needs to send a message to markets on its view of the future interest rate path, and the government needs a convincing plan on how to put Japan's fiscal house in order," he said.
The policy divergence between the BOJ and the U.S. Federal Reserve, which is raising interest rates aggressively, has pushed the yen to 24-year lows, further inflating costs of imported fuel and food.
"While it can't directly target the yen in setting monetary policy, the BOJ may be forced to address the effect of the weak yen on inflation from the standpoint of achieving price stability," Yamaoka said.
"If so, maintaining the 0.25% yield cap becomes difficult."