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TOKYO (Reuters) - The Bank of Japan is expected to hold off on easing monetary policy on Thursday, convinced that the country's economy is headed for a moderate recovery as strength in domestic demand eases the pain from slowing global growth.
Some market players had expected the BOJ to follow up on last week's stimulus measures by the central banks of Europe, Britain and China with its own monetary expansion in a coordinated move to ease the pain from the global slowdown.
But with no clear signs yet that Japan's recovery prospects are under threat, the BOJ sees little reason to tap its depleted arsenal now unless a sudden spike in the yen hits business sentiment.
The central bank in fact may offer a slightly more upbeat view on the economy than last month, when it said growth was starting to pick up, as Monday's tankan survey showed that companies are more optimistic about business conditions and plan to increase capital expenditure this fiscal year.
"Recent Japanese indicators, including factory output and the tankan survey, aren't that bad. They don't point to the need for additional monetary easing by the BOJ," said Naoki Iizuka, senior economist at Mizuho Securities in Tokyo.
"But there are a considerable number of market players still expecting the BOJ to ease in July, so a lack of action could be taken as a negative surprise and push down stock prices."
The central bank is widely expected to keep its policy rate at a range of zero to 0.1 percent, and hold off on easing policy such as a further increase in its 40-trillion-yen ($503 billion) asset buying program.
The BOJ set a 1 percent inflation target and eased policy in February, and followed up with additional stimulus in April, to show its determination to beat deflation that has plagued Japan for more than a decade. It has stood pat on policy since then.
BOJ officials have stressed that any further easing will come only if risks to Japan's economy heighten enough to force the central bank to abandon its forecast of a moderate recovery.
They fret about slowing Chinese growth and the fallout from Europe's debt crisis, which could prevent global growth from picking up in time to support Japan's economy when the boost from reconstruction spending starts to fade early next year.
But exports and factory output have held up so far while the yen is off its record highs, giving the central bank some breathing room. A record fall in May machinery orders reported on Monday, while worrying, is also not enough to nudge the BOJ into acting now, analysts say.
In a quarterly review of its forecasts on Thursday, the BOJ is expected to make only minor tweaks to its current projection that the economy will expand 2.3 percent in the fiscal year to March 2013 and 1.7 percent the following year, say sources familiar with its thinking.
Recent declines in commodity prices may prompt the BOJ to cut its core consumer inflation forecast of 0.3 percent for the current fiscal year but probably just by around 0.1 or 0.2 percentage points, not enough to alter its view that Japan will gradually head toward 1 percent inflation, they said.
Its forecast of 0.7 percent consumer inflation in the following year will likely remain roughly unchanged.
Bond yields fell last week on market speculation that the BOJ may follow the footsteps of the European Central Bank and cut to zero the 0.1 percent interest paid to financial institutions' deposits with the central bank, to force-feed cash to markets more easily.
But the BOJ does not see this as a realistic option because it would discourage financial institutions from lending to each other and distort market functions.
($1 = 79.5300 Japanese yen)
Editing by Kim Coghill