By Leika Kihara and Andrea Shalal
TOKYO/WASHINGTON (Reuters) -The Bank of Japan should start preparing for future monetary tightening by moving away from its yield control policy, the International Monetary Fund's chief economist Pierre-Olivier Gourinchas said on Tuesday.
The remarks came ahead of the BOJ's closely-watched meeting on Friday, where the board will release fresh price forecasts and debate whether to tweak its controversial yield curve control (YCC) policy as inflation stays above its 2% target.
"Right now, the risk is probably on the upside, that maybe inflation pressures will continue to remain above the target," Gourinchas said on Japan's inflation outlook.
"Our advice for Japanese authorities there is that right now, monetary policy can remain accommodative, but it needs to prepare itself for the need to maybe start hiking," Gourinchas told a news conference held after the release of the IMF's updated World Economic Outlook report.
He said the IMF was encouraging Japan to "be a bit more flexible and maybe move away from the yield-curve control that it has now."
With inflation exceeding its target, markets are rife with speculation the BOJ could soon phase out its massive stimulus starting with a tweak to YCC - a policy that caps the 10-year bond yield around 0% with an implicit ceiling of 0.5%.
Sources have told Reuters the BOJ is leaning towards keeping YCC unchanged this week, though there is no consensus within the bank on how soon it should start phasing out stimulus.
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.
Japan's business-to-business service inflation eased in June, data showed on Wednesday, a sign companies were slow in passing on rising labour costs despite a tight job market.
Underscoring the pressure the BOJ faces, however, Japan's top financial diplomat on Friday suggested the central bank may tweak its approach to monetary stimulus due to "signs of change" in corporate price and wage-setting behaviour.
BOJ officials, including governor Kazuo Ueda, have stressed the need to keep ultra-loose policy until there is more evidence inflation will sustainably hit 2% backed by strong wage growth. They have also said the BOJ was mindful of the cost of YCC such as market distortions caused by its heavy bond buying.
Widening the allowance band around its 10-year yield target, a step it took last December, could be among options to mitigate the side-effects of YCC, analysts say.
In the updated World Economic Outlook report, the IMF said it expects Japan's economy to expand 1.4% in 2023, faster than a 1.0% rise last year, as the removal of pandemic curbs boosts consumption.
It also cited "accommodative policies" as underpinning growth, as Japan keeps interest rates low and continues big fiscal spending to cushion the blow from rising living costs.
Growth in the world's third-largest economy is expected to slow to 1.0% in 2024 as the effect of past stimulus measures dissipate, the IMF said.