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The Bank of Japan looks increasingly likely to cut its inflation forecasts next month, sources say, making its target of 2 percent in the year from April look ever more ambitious, just three months after it eased monetary policy to keep the goal in sight.
The BOJ surprised markets on Oct. 31 with its decision to flood the market with cash to counter the effect of slumping oil prices and weak domestic demand on inflation expectations, but oil prices have fallen 15 percent since then.
Some central bankers now fear core consumer inflation will slow to about 0.5 percent by the middle of next year as gasoline and electricity bills fall, down from May's peak of 1.4 percent and far below the 2 percent target BOJ Governor Haruhiko Kuroda has committed to achieve.
Oil price falls are helpful for Prime Minister Shinzo Abe's "Abenomics" policies, which are aimed at reinflating the economy, as households and companies pay less for fuel imports, but make it harder for the BOJ to lift Japan clear of two decades of crippling deflation.
The bank will issue fresh quarterly forecasts at a rate review on Jan 21-22.
Barring a sharp rebound in oil prices, the BOJ may slightly cut its core consumer inflation forecast for the current fiscal year from the 1.2 percent projected on Oct. 31, which took into account the new monetary stimulus, according to four sources familiar with the bank's thinking.
Pessimists on the board might also consider cutting their inflation forecasts for the fiscal year beginning in April. That could mean a small downgrade in the board's median forecast from the 1.7 percent projected in October, the sources said on condition of anonymity.
This time, however, the central bank appears to be in no mood to add more monetary stimulus to boost the January inflation forecasts as it did in October.
"The October action pre-empted a lot of risks. The BOJ won't respond just to oil price swings," said one of the sources.
Takehiro Sato, who is among those board members pessimistic about the use of monetary easing - four of the nine voted against it in October - said last week that while consumer inflation might stall until around the middle of next year due to slumping oil prices, he saw no need for action.
Many in the bank prefer to wait at least until April, when there is more clarity on whether Japan's employers will respond to Abe's urging to raise salaries in the spring wage negotiations.
They are hopeful that economic growth will overshoot expectations next fiscal year as exports pick up and companies boost capital spending. Abe's decision to delay a scheduled sales tax hike next year also eases the pain on households.
To stave off speculation of immediate stimulus, the BOJ has started to emphasize the merits of lower oil prices, saying they will boost corporate revenues and allow firms to increase wages. Such long-term positive effects will help push up inflation with a lag of about a year, some BOJ officials say.
Given data showing Japan slipped into recession in the third quarter, the BOJ is also seen cutting this fiscal year's economic growth forecast to around zero from the 0.5 percent expansion projected in October, the sources say.
Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute, expects core consumer inflation to hover around, or even slip below, 1 percent in the current and next fiscal years if crude oil prices don't rebound much from present levels.
"Cuts in this fiscal year's economic and price forecasts are inevitable," Shinke said. "If the BOJ sticks to the logic it used to explain its October action, it will have to ease again."
Since deploying its quantitative easing program in April last year, the BOJ has repeatedly cut its economic forecasts but has rarely slashed its price projections from levels many analysts consider too ambitious.
"The oil price fall is gift from god for Abe ... but a source of headache for Kuroda, who wants to achieve his 2 percent inflation target at an early date," said Ryutaro Kono, chief Japan economist at BNP Paribas Securities.