(This July 20 story has been corrected to change the attribution to senior Japan economist at UBS Securities, not economist at JPMorgan Chase (NYSE:JPM) in paragraph 5)
By Leika Kihara
TOKYO (Reuters) - Japan's government on Thursday forecast inflation sharply exceeding the central bank's 2% target this year, acknowledging broadening price rises that may keep alive market expectations of an end to ultra-low interest rates.
The estimates come ahead of closely watched Bank of Japan policy meeting next week, when the board will revise its quarterly forecasts and debate progress on sustainably meeting its price target.
In its mid-year review, the government expects overall consumer inflation to hit 2.6% for the fiscal year that began in April, up sharply from 1.7% projected in January. Inflation last year was 3.2%.
The government projects inflation to slow next fiscal year but, at 1.9%, stay close to the central bank's target.
"The government's inflation forecasts are well in line with market forecasts. It wouldn't surprise me if the BOJ revises up its price projections this month," said Masamichi Adachi, senior Japan economist at UBS Securities.
Underscoring the fragile nature of Japan's recovery, the government slashed its economic growth forecast for this fiscal year. It expects the economy to expand 1.3% this fiscal year, below the 1.5% estimated in January, due to a hit to exports from slowing global demand.
"Japan's economy is recovering moderately" with positive signs emerging, such as steady wage hikes and strong corporate spending appetite, Prime Minister Fumio Kishida said.
"It's important to ensure Japan makes steady progress in exiting deflation, and shift to a society where wage hikes become a norm," he told the government's top economic council.
After more than two decades of deflation and stagnant wage growth, Japan has seen inflation exceed the central bank's 2% target for more than a year as firms continued to pass on rising raw material costs to households via price hikes.
Companies offered pay raises unseen in three decades at this year's wage negotiations with unions, heightening market expectations of a tweak to the BOJ's yield curve control (YCC) policy, which caps long-term interest rates around zero.
BOJ Governor Kazuo Ueda has brushed aside the chance of a near-term exit from ultra-loose policy, arguing that the recent cost-driven rise in inflation must be replaced by price gains driven more by robust domestic demand and higher wage growth.
But an upgrade to its inflation forecasts will likely keep alive market expectations that Ueda will soon start to phase out his predecessor's massive stimulus programme.
In its April forecasts, the central bank predicted core consumer inflation - which strips away the effect of fresh food costs - to hit 1.8% this fiscal year and 2.0% the following year.