The Bank of Japan maintained its massive monetary stimulus on Friday and upgraded its view on capital expenditure, encouraged by growing signs that the benefits of its aggressive policy action to escape deflation are broadening.
After a two-day review, the central bank reiterated its view the world's third-largest economy is recovering moderately, suggesting that no additional monetary policy measures are needed to counter the pain from next year's sales tax hike.
"Capital expenditure is picking up as corporate profits improve," the BOJ said in a statement. That was slightly more optimistic than last month, when it said capital spending was showing signs of a pick-up.
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As widely expected, the BOJ kept intact its April commitment to double base money via asset purchases to meet its target of lifting inflation to 2 percent in roughly two years.
The policy review followed Prime Minister Shinzo Abe's decision on Tuesday to proceed with a planned increase in the sales tax to 8 percent from 5 percent next April and cushion its impact with a 5 trillion yen ($51 billion) stimulus package.
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In a news conference later on Friday, BOJ Governor Haruhiko Kuroda is expected to welcome Abe's decision as an important first step in reining in Japan's huge public debt which, at double the size of its $5 trillion economy, is the biggest among major industrialized nations.
The BOJ expects the sales tax increase to shave about 0.7 percentage point off growth. For now, it sees no need to expand its stimulus further, confident that the world's third-largest economy can withstand the hit.
"I don't think the BOJ's view that the sales tax hike won't derail the recovery is too optimistic," said Junko Nishioka, chief Japan economist at RBS Securities.
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"But the 2 percent inflation remains a distant goal. Core consumer inflation could hit 1 percent early next year. But it's an uphill battle from there."
Sources familiar with the BOJ's thinking say given the tax rise is factored into its outlook, the government's stimulus package could see the central bank revise up its long-term growth forecasts, due for release on Oct. 31.
The board was expected to have debated the benefits the fiscal package will deliver to the economy, as well as global risks such as the U.S. government shutdown and the October 17 deadline for a deal to raise the U.S. debt ceiling.
Big test next year
Japan's economy has now grown for three successive quarters as Abe's reflationary policies bolstered household spending and drove down the yen, benefiting exports, with annualized growth of 3.8 percent in April-June outpacing many G7 nations.
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Big manufacturers' sentiment has risen to its highest in nearly six years, the BOJ's "tankan" survey for the September quarter showed, underscoring its view the economy is on track for a moderate recovery.
Policymakers see capital expenditure and wage growth as key in achieving a sustained economic recovery and pulling Japan out of deflation, because companies have been hoarding cash instead of spending for decades due to the murky economic outlook.
The BOJ estimates that even with the sales tax increase, the economy will expand 1.3 percent in the business year beginning in April next year. This already far outpaces the 0.7 percent growth projected in a recent Reuters poll.
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Having launched its intense burst of stimulus in April, the BOJ does not want to act again easily. But it has not ruled out expanding stimulus if the damage from the tax hike proves bigger than expected and threatens achievement of 2 percent inflation.
The big test will come in spring next year, and not just from the sales tax hike. There will also be more clarity on whether companies will raise wages enough to offset some of the pain households will feel from the tax hike, BOJ officials say.