TOKYO (Reuters) - Bank of Japan policymakers gathering for a rate review this week will face the daunting task of coming up with a reason why they can hold off on expanding stimulus for now, even as slumping oil prices keep inflation further away from their 2 percent target.
Less than three months ago, the BOJ justified its shock expansion of "quantitative and qualitative easing" (QQE) as aimed at preventing oil price falls, and a subsequent slowdown in price rises, from weighing on inflation expectations.
The move kept alive market speculation that the relentless drop in oil prices, which have nearly halved since October, will force the BOJ to ease again in coming months.
At the two-day rate review ending on Wednesday, the BOJ is set to cut its core consumer inflation for next fiscal year below 1.5 percent from 1.7 percent projected in October, sources familiar with the bank's thinking said.
With the BOJ's massive purchases already pushing yields into negative territory, many board members want to hold off on expanding QQE for now.
The BOJ may therefore instead expand two loan schemes aimed at encouraging banks to boost lending and extend their deadlines beyond March, sources say.
But a surprise increase of asset purchases under QQE cannot be ruled out if the BOJ board's median inflation forecast for next fiscal year falls below 1 percent, some analysts say.
"By tying its October action to oil moves, the BOJ fell into its own trap," said Izuru Kato, chief economist at Totan Research. "Cheap oil benefits a huge importer like Japan. It's only a problem for the BOJ."
In the quarterly review of its long-term projections, the BOJ is also set to revise up its economic growth forecast for next fiscal year, sources have said.
That may help the BOJ justify standing pat on policy. It hopes to argue that improvements in the economy will narrow the output gap and lead to wage hikes, offsetting the temporary downward pressure from oil price falls.
The BOJ issues a semi-annual report with forecasts on the economy and prices in April and October of each year. It reviews the projections at rate reviews in January and July. Many private analysts expect consumer inflation to hover below 1 percent next fiscal year and the following year.
Under QQE, the BOJ has pledged to double base money via aggressive asset purchases to achieve 2 percent inflation during the next fiscal year beginning in April.
Editing by Eric Meijer