By Leika Kihara
TOKYO (Reuters) - The Bank of Japan is set on Tuesday to unveil its most determined effort yet to beat years of economic stagnation, but the big challenge will be how to impress markets already pricing in a doubling of its inflation target and further asset buying.
Under pressure from new Prime Minister Shinzo Abe for bolder action to overcome deflation and lift the economy out of recession, the central bank will issue a joint statement with the government pledging to pursue aggressive monetary easing to achieve a target for inflation of 2 percent, a level achieved in only a handful of months since the late 1990s.
Such a pledge will keep the BOJ under political pressure to deliver economic stimulus steps beyond its regular policy prescription of the past few years of topping up an asset-buying and lending programme, analysts say.
"This will be a historical meeting for the BOJ that marks a big change in its policy framework, so the bank will be under pressure to deliver something new," said Masaaki Kanno, chief Japan economist at JPMorgan Securities.
"Doing the same thing it did in December won't be enough. The BOJ needs to show it has changed. Otherwise, we may see a reversal in the current yen-weakening trend," he said.
The yen has dropped 13 percent against the dollar in the past two months to hit a two-and-a-half-year low on expectations Abe will force the central bank into bolder action. Tokyo stocks have jumped by a fifth on the view the weaker yen will boost the export earnings of the likes of Nissan Motor Co and Canon Inc.
That leaves room for market disappointment, analysts say, if the central bank does no more than announce its new inflation target and raise the ceiling of its asset-buying programme by 10 trillion yen, the most regular increment in policy easings of the past year.
Instead, policymakers will have to consider other measures to impress investors and keep pressure on the yen, considered key to Japan's economic fortunes as the country struggles with its fourth recession since 2001.
One option would be to make an open-ended pledge to buying assets. The ceiling on the current programme is 101 trillion yen and it runs until the end of the year.
Another option would be to scrap a 0.1 percent floor paid on short-term deposits at the central bank to encourage lending, sources have told Reuters.
A joint BOJ and government statement will likely set 2 percent inflation as a medium-term target without a binding deadline. The hope is that modestly rising prices will lift the economy by encouraging consumers to buy before prices get any higher.
Sources said the BOJ governor will be asked to report regularly to the government's top economic council on progress towards achieving the inflation target.
For the government's part, Abe has promised a boost to spending to help get the economy back on its feet. Abe's stimulus may give the economy only a temporary boost at best unless he follows through with politically more difficult economic reforms, such as deregulating protected sectors such as agriculture, analysts say.
Still, Abe is likely to keep pressure on the BOJ for more stimulus even after Tuesday's meeting at least until an upper house election expected in July.
Abe is also expected to try to install a central bank governor more sympathetic to aggressive monetary policy easing when incumbent Masaaki Shirakawa's term ends in April. Shirakawa has maintained that monetary policy alone can not pull the economy out of deflation.
(Editing by Neil Fullick)