By Leika Kihara and Yoshifumi Takemoto
TOKYO (Reuters) - The Bank of Japan (BOJ) must redefine its inflation target and phase out a radical yield-cap policy to mitigate mounting costs of prolonged monetary easing, Yuri Okina, a member of a key government panel and possible future BOJ executive, said on Friday.
The BOJ remains an outlier in a global a wave of central banks tightening monetary policy by maintaining yield curve control (YCC), a policy under which it guides short-term interest rates at -0.1% and caps the 10-year bond yield around 0%.
The negative short-term rate and the BOJ's relentless defense of its yield cap have drawn criticism for distorting the shape of the yield curve and crushing commercial banks' margins.
"Given the strong side-effects, the BOJ must review its current policy when the appropriate time comes" by tweaking both the negative rate target and the 10-year yield cap, Okina told Reuters in an interview.
"While interest rates need to stay low for the time being, the BOJ must head toward policy normalisation in the long run," said Okina, who is seen as among candidates to join the central bank's leadership when the posts of governor and two deputy governors open up next year.
The BOJ must also re-define its 2% inflation target as a long-term goal with some leeway, instead of the current "rigid" definition that could force it to keep ultra-low rates for longer than desirable, she said.
"The 2% inflation target shouldn't be considered a binding rule that prevents the BOJ from tweaking monetary policy even when it needs to," said Okina, a former central bank official.
Annual core consumer inflation exceeded the BOJ's 2% target for sixth straight month in September as the weak yen, driven in part by the central bank's low-rate policy, pushed up imported goods prices and households' cost of living.
BOJ Governor Haruhiko Kuroda has repeatedly said the central bank must hold off from adjusting YCC until its 2% inflation target is sustainably achieved and accompanied by wage rises.
While adjustment to YCC may not happen during what is left of Kuroda's term as governor, which will end in April, the BOJ should not wait too long in moving towards an exit, Okina said.
"Making structural changes to raise wages will take a long time. The BOJ shouldn't wait that long" in normalising policy, said Okina, who is currently a member of a government panel debating Prime Minister Fumio Kishida's growth strategies.
She is also the head of private think tank Japan Research Institute.