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After 'Shock and Awe,' What Next From the BOJ?

Haruhiko Kuroda, governor of the Bank of Japan
Andrew Harrer | Bloomberg | Getty Images
Haruhiko Kuroda, governor of the Bank of Japan

The Bank of Japan (BOJ) meets on Friday for the first time after it made a radical shift in policy earlier this month and market watchers are now looking at the central bank's next move in its battle to end deflation that has dogged the world's third biggest economy for two decades.

The BOJ, which has traditionally adopted a cautious approach, shocked markets at its last meeting on April 4 when it said it would pump $1.4 trillion in to the economy in less than two years and double its monetary base to meet a 2 percent inflation target by 2016.

With that inflation target in mind, Japanese media have been awash with reports in the past week that the BOJ will raise its inflation forecast to at least 1.5 percent for the fiscal year ending March 2015. The current forecast is 0.9 percent.

As well as holding a policy meeting on Friday, the BOJ is due to release its semi-annual forecasts on economic growth and inflation trends.

(Read More: Unlike the Fed, BOJ's QE Won't Unleash Hot Money)

"One way to implement unconventional monetary easing is to target the inflation forecast and the thinking goes that if the forecast doesn't materialize this would indicate an intensification of the unconventional measures," said Tim Condon, head of research for Asia at ING Financial Markets in Singapore.

"That's why there is interest in whether they will move to a policy of targeting the forecast and if it happens it would increase the likelihood of the BOJ succeeding," he added.

Raising the inflation forecast could also help push the yen through the 100-barrier against the dollar, currency analysts say.

The yen, which has shed some 25 percent of its value against the dollar since mid-November on expectations for aggressive monetary easing, is hovering near the key-100 level versus the dollar. A significant break of the psychological barrier is expected to bring further falls for the yen.

"They're not going to change policy, but they could change their forecasts," Mansoor Mohi-Uddin, chief currency strategist at UBS Investment Bank told CNBC's "Asia Squawk Box" on Thursday.

"That could encourage the Japanese to think that the BOJ will get to its target and could push dollar/yen through 100," he added.

(Read More: Why the Hype Over Dollar-Yen at 100 Is Overdone)

Credibility at Stake

By pursing radical monetary policies to boost prices and revive the Japanese economy, the central bank has put its credibility on the line, BOJ watchers say.

"Whenever a central bank makes a move its relying on its credibility to carry that move through and that's even more the case when the move is big," said ING's Condon.

Friday's meeting will be just the second under new Governor Haruhiko Kuroda.

"I don't often get excited about inflation, but I do think the BOJ needs to be steadfast about what it wants to achieve," said David Greene, senior corporate forex dealer at Western Union Business, in Sydney. "And we don't have a track record with Kuroda, his predecessor, we did. His approach was detrimental to the economy and we need someone in Japan that will provide a clear steer."

Japan has suffered for some time from falling prices and has slipped in and out of recession in recent years. Prime Minister Shinzo Abe, whose ruling Liberal Democratic Party came to power in December, has pledged to kick start economic growth.

"The problem for the Bank of Japan is it's going to need more time to see that this [aggressive monetary easing] is a durable policy," said Vincent Trugulia, international economist at Clear and Candid Economic and Political Analysis in New York. "It's going to be hard because Japan has been suffering from deflation for two decades."

- By CNBC.Com's Dhara Ranasinghe; Follow her on Twitter @DharaCNBC

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