Talk that the Bank of Japan (BOJ) could ramp up its aggressive monetary easing program should the government press ahead with a controversial rise in the country's sales tax is gaining ground.
Citing several sources, Japan's Asahi newspaper reported earlier this week that the BOJ would consider further monetary easing if a rise in the consumption tax goes through. The BOJ offered some clarification on Thursday, saying it would only expand its stimulus program if the sales tax hike became a hurdle in its quest to achieve its 2 percent inflation target in two years.
In the run up to Prime Minister Shinzo Abe's final decision next month, there has been a heated debate about the consumption tax, which is scheduled to rise from 5 percent to 8 percent next April, and to 10 percent in October 2015. Two camps have emerged: those that argue a tax rise is crucial to alleviating Japan's fiscal position and those who feel it will undermine the country's economic recovery.
Those in favor of the sales tax hike believe it's necessary to relieve Japan's debt burden which is the heaviest in the world with national debt well above 200 percent of gross domestic product. Those against it believe a tax hike will derail the nascent economic recovery and Abe's attempts to boost consumption.
"[BOJ Governor Haruhiko] Kuroda pretty much spelled out the tax should be implemented in April, however we don't know at exactly what point the bank could ease further," said Chris Weston, chief market strategist at trading firm IG. "The devil here is in the detail and we don't know if Abe will put the tax up from 5 to 8 percent or whether he moves in 1 percent increments."
A government panel, which met last week, recommended proceeding with the sales tax but proposed stimulus to cushion the blow.
According to some currency analysts, the prospect of more monetary stimulus in Japan is one reason why the yen has weakened back past the 100 mark against the dollar this week.
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"It is clear that Japanese monetary officials are afraid that an expansionary monetary policy without the concomitant fiscal tightening could wreak havoc in the JGB [Japanese government bond] market, but by arguing for the sales tax now, they risk the prospect of snuffing out the country's nascent and fragile economic recovery," Boris Schlossberg, managing director at BK Asset Management, said in a note.
The BOJ on Thursday reiterated its pledge to increase Japan's base money, the cash and deposits at the central bank, at an annual pace of 60 trillion yen ($603 billion) to 70 trillion yen – the aggressive monetary stimulus that has helped drive the yen down 16 percent against the dollar this year.
—By CNBC.Com's Dhara Ranasinghe; Follow her on Twitter @DharaCNBC