By Leika Kihara and Tetsushi Kajimoto
TOKYO (Reuters) -Incoming Bank of Japan (BOJ) Governor Kazuo Ueda said on Monday he had ideas on how the central bank could exit its massive stimulus, but a shift to tighter policy would only come when the country's trend inflation heightens significantly.
The central bank will reduce its bond buying and likely head toward policy normalisation when sustained achievement of its 2% inflation target comes into sight, Ueda said.
With trend inflation short of the BOJ's target, however, the central bank must maintain current ultra-easy policy for now, he added.
"Big improvements must be made in Japan's trend inflation for the BOJ to shift towards monetary tightening," Ueda said.
"It's not that I have no ideas on how to tweak the BOJ's current policy. But the desirable tweak will vary depending on economic changes at the time," Ueda said, adding it was premature to comment on how the central bank may shift policy.
Ueda said he was open to the idea of conducting a comprehensive review of the BOJ's monetary easing framework, which has been proposed by board member Naoki Tamura.
"If the BOJ were to do a review, my feeling is that it should spend plenty of time to look into various aspects of its monetary easing," he said, suggesting that any overhaul of Yield Curve Control (YCC) may not come immediately after he takes the helm in April.
When the government named the 71-year-old academic earlier this month as its pick to become the next central bank governor, markets saw the surprise choice as heightening the chance of an end to the YCC policy, which has drawn public criticism for distorting market functions and crushing banks' margins.
While Ueda did not specifically define what constituted trend inflation, he said it was "above zero but short of 2%" and serving as a key gauge of the BOJ's monetary policy decision.
For now, the BOJ's ultra-loose policy was appropriate as the benefits of the policy, such as the boost to growth, exceeded the costs like deteriorating market functions, he said.
"If trend inflation does not perk up, the BOJ must shift to a more sustainable policy or monetary easing framework to look after the cost of its stimulus," Ueda told an upper house confirmation hearing.
Ueda said he saw no need for now to change the BOJ's 2% inflation target or language in a joint statement that the government signed in 2013 and commits the central bank to hitting the price goal at the earliest date possible.
He also said while it was premature to discuss specifics of an exit strategy, the BOJ must "always conduct various simulations" of an exit plan even before sustained achievement of its 2% inflation target is foreseen.
Upon approval by parliament, Ueda succeeds incumbent Haruhiko Kuroda, who leaves behind a massive asset-buying programme and a controversial bond yield control policy as his second, five-year term ends on April 8.
While praising Kuroda's policy for having reflated growth, Ueda said big monetary stimulus alone cannot fire up inflation especially when the economy is hit by large external shocks.
He also said the BOJ must be mindful of an unwelcome overshoot of inflation by maintaining a commitment to keep increasing money printing until inflation exceeds its 2% target.
"Monetary policy can push up inflation. But that's not the only factor that affects prices," he said.
The BOJ has been forced to ramp up bond buying to defend its 0.5% cap set for the 10-year bond yield under YCC, leading some market players to bet it will tweak or abandon the policy soon.
Ueda said the BOJ must scrutinise whether the steps taken so far will be enough to address market distortions caused by YCC, but declined to comment on what further measures could be taken once he takes the helm.
The upper house hearing follows testimony at the lower house of parliament on Friday, where Ueda stressed the need to maintain ultra-loose policy for now.
His nomination needs the approval of both chambers of the Diet, which is effectively a done deal as the ruling coalition holds solid majorities in both.