TOKYO, Jan 23 (Reuters) - The Bank of Japan is set to keep interest rates steady on Friday and signal cautious optimism that the economy will maintain a moderate recovery that would justify raising still-low
borrowing costs further.
BOJ Governor Kazuo Ueda is likely to offer few clues on when the bank might next raise rates, a decision complicated by a fresh bout of market volatility caused by Prime Minister Sanae Takaichi's decision to call a snap election next month.
The central bank is caught between a need to keep yen bears at bay with hawkish communication, without triggering further rises in bond yields on expectations of hefty spending by Takaichi's government.
Last month, the central bank raised its key policy rate to a 30-year high 0.75%. It is expected to announce the result of its two-day meeting between 12:30 p.m. and 2 p.m. (0330-0500 GMT).
BOJ LIKELY TO RAISE GROWTH FORECAST, SOURCES SAY
In a quarterly outlook report, the BOJ will likely raise its growth forecast for the fiscal year beginning in April, and maintain its view the economy will remain on course for a moderate recovery, sources have told Reuters.
The central bank is also expected to maintain its pledge to keep raising rates if economic and price developments move in line with its projections.
With expectations of an immediate policy change low, markets are focusing on Ueda's post-meeting press conference at 3:30 p.m. (0630 GMT) for hints on how the yen's recent weakness, which pushes up import costs and broader inflation, could affect the pace and timing of future rate hikes.
"Despite December's rate hike, the yen has continued to weaken rapidly, which could see the pass-through of higher import prices to domestic consumers accelerate," said Kei Fujimoto, senior economist at SuMi Trust.
"To combat this, the BOJ may need to raise rates at a faster pace," Fujimoto said, predicting two rate hikes this year.
Japan's economy has weathered the hit from U.S. tariffs and is likely to get a lift from Takaichi's stimulus package focusing on steps to cushion the blow from rising living costs.
BOND YIELD SPIKE MAY THREATEN BOJ'S TIGHTENING
But the premier's vow to strengthen her expansionary fiscal policy and suspend the 8% sales tax on food have stoked fears of additional debt issuance, leading to the spike in bond yields, which could hurt the economy.
The weak yen has kept food prices high for longer than expected and could give firms a justification to boost prices further in coming months.
The yield spike has drawn renewed attention to the BOJ's quantitative tightening plan, under which it has been unwinding its years of massive stimulus by gradually slowing its bond buying at a set pace to reduce its huge balance sheet.
Some analysts say the BOJ could suspend this tapering or conduct emergency bond-buying operations - tools it has to cope with extreme market stress.
But the BOJ is unlikely to deploy these measures immediately, as ramping up bond-buying would run counter to its efforts to wean the economy off the stimulus it deployed to fight years of deflation, analysts say.
The BOJ changed direction in 2024, raising its policy rate several times and tapering bond purchases on the view Japan was on the cusp of durably achieving the bank's 2% inflation target.
(Reporting by Leika Kihara; Editing by William Mallard)
