The Bank of Japan will consider making an open-ended commitment next week to buy government bonds and other assets until 2 percent inflation is in sight and the economy is on a more solid footing, according to sources familiar with its thinking.
The central bank will also consider scrapping interest it pays on banks' reserves, the sources added.
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Faced with relentless pressure from Prime Minister Shinzo Abe to do more to pull Japan out of deflation, the BOJ is expected to double its inflation target and possibly boost its long-running asset-buying scheme at a two-day policy review that ends on Tuesday.
Any steps beyond that, however, would come as a surprise for investors, possibly putting the yen under more selling pressure and further boosting Japanese stocks, which have bolted to their highest levels in nearly three years on hopes of bolder policy measures.
The BOJ and the government are in final talks on the contents of a joint policy statement they aim to issue on January 22, and both have already agreed on the 2 percent inflation goal, deputy economics minister Yasutoshi Nishimura told Reuters in an interview on Friday.
"Governor (Masaaki) Shirakawa has been saying that 1 percent inflation would be in sight before long but we have not reached that stage yet," Nishimura said.
"If we share 2 percent inflation as a common objective, we expect the BOJ to do something very aggressive."
But it has not been decided whether the statement will include job growth as the central bank's mandate and how to describe the timeline for achieving the inflation target, although it is unlikely to set a specific deadline, he said.
MORE UNCONVENTIONAL STEPS
Abe, who led his Liberal Democratic Party to a landslide victory in a December 16 election with promises of aggressive budget and monetary stimulus, has suggested adding job creation to the BOJ's policy goals and making 2 percent inflation a medium-term goal that should be achieved in two to three years.
Both are problematic for central bankers, who argue monetary policy alone cannot achieve those goals and are wary of committing to binding targets and deadlines.
But aware that investors have already priced in the new inflation target and another expected increase of 10 trillion yen ($112 billion) in the BOJ's asset buying and lending scheme -- since October 2010 its main policy tool -- central bankers are discussing other unconventional steps to maximize market impact, sources told Reuters.
One option would be to replace incremental increases in the asset programme with a U.S. Federal Reserve-style open-ended pledge to continue buying assets until the inflation goal is within reach, without setting a deadline for completing the purchases, the sources said.
Another idea would be to pledge to maintain the balance of the programme even beyond its end-2013 deadline, they said.
The BOJ will also consider scrapping the 0.1 percent interest paid on financial institutions' reserves held with the central bank, according to the sources, who spoke on condition of anonymity due to the sensitivity of the matter. That rate has effectively served as a floor to money market rates and kept them from falling to zero.
Such a proposal from BOJ board member Koji Ishida was voted down by 8-1 at the December meeting, but another board member, Sayuri Shirai, said in a recent speech that the idea was worth considering as a way to further push down interest rates and help further weaken the yen.
The new government's push for more public spending -- it approved 10 trillion yen in extra spending last week -- and aggressive monetary easing has helped reverse the yen's gains, setting off stock market rally led by exporters and construction firms.
But many economists warn the stimulus may give the sluggish economy only a temporary jolt at best if Abe's government fails to follow through with politically more difficult economic reforms needed to lift Japan's long-term growth potential.
They also warn that the push to reflate the economy long-trapped in sub-par growth and low-grade deflation could backfire if the new government's medium-term fiscal plan due in mid-2013 fails to convince markets that it can get Japan's ballooning debt back under control.
Shirakawa met with Finance Minister Taro Aso and Economics Minister Akira Amari on Friday to narrow their differences over the statement they aim to issue next week. The ministers are due to fine-tune the statement with Abe once he returns from a trip to Southeast Asia, according to a government source.
($1 = 88.4950 Japanese yen)
(Additional reporting by Yoshifumi Takemoto, Sumio Ito and Stanley White; Writing by Tomasz Janowski; Editing by Kim Coghill)