Bank of Japan Governor Masaaki Shirakawa said the central bank will continue to pursue powerful monetary easing, taking into account the risk that rises in the yen can hurt Japan's economy.
But he stressed that flooding markets with cash alone won't nudge up prices in countries like Japan where interest rates are already near zero, repeating his call for government efforts to boost growth potential such as deregulation and structural reform.
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"We are always watching with great interest how currency moves could affect the economy and prices," Shirakawa said at a seminar on Monday, warning that yen rises can undermine the economy by hurting exports and business sentiment.
"The BOJ's powerful monetary easing has had some effect in stemming yen rises by pushing down interest rates," he said, signaling that the pain from increases in the yen's exchange value will be among key factors the central bank will scrutinize in guiding policy.
But Shirakawa warned that there was no clear relationship seen between the size of the monetary base and exchange-rate moves, countering views held by some lawmakers and analysts that the BOJ could weaken the yen by pumping money into the economy more aggressively.
Shirakawa also shrugged off calls for the central bank to directly buy foreign bonds, repeating the bank's view that it was prohibited from doing so under the current law that gives the finance ministry - not the BOJ - jurisdiction over exchange-rate policy.
He offered a downbeat assessment of Japan's economy, saying it is expected to stagnate for the time being with worsening relations with China damaging trade and Japan's tourism industry.
"Exports and output are likely to remain weak, and domestic demand won't increase enough to make up for the weakness in exports," he said.
The BOJ eased monetary policy for the second straight month in October as slowing global demand and fallout from a territorial row with China nudge the world's third largest economy into recession.
Data published on Monday showed Japan's economy shrank 0.9 percent in the three months to September, marking the first contraction in three quarters, keeping the central bank under pressure to offer further stimulus.
Economics Minister Seiji Maehara kept up the heat, telling reporters on Monday that he expects the central bank to pursue powerful easing.
(Additional reporting by Kaori Kaneko; Editing by Michael Watson and Eric Meijer)