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Bank of Japan in hot seat to produce inflation

Akio Kon | Bloomberg | Getty Images

With Japan's economy officially out of technical recession, the Bank of Japan (BOJ) this week will likely shift focus back to inflation, analysts say, with markets paying particular attention to how Governor Haruhiko Kuroda will react to questions about price targets.

"The main point will be whether the Bank of Japan officially acknowledges a delay in its target date," said Deutsche Bank Chief Economist Mikihiro Matsuoka in a note. Although "the deadline for achieving the bank's price stability target has become somewhat ambiguous," he added.

The Bank of Japan launched an open ended and unprecedented quantitative easing program in April 2013, and expanded the scheme last October as the economy entered recession in the third quarter after two consecutive quarters of contraction.

Data released on Monday showed the economy emerging from recession, growing an annualized 2.2 percent in the fourth quarter, bringing some relief to markets.

Majority of analysts expect the BOJ to stand pat on monetary policy on Wednesday after a two-day meeting but the question remains if Kuroda will finally concede defeat in his quest for 2 percent inflation by the next financial year.

The governor has repeatedly defended the target even as the central bank last month cut its inflation forecast for the fiscal year ending March 2016 to 1.0 percent, half of the 2 percent target it set nearly two years ago. Stripping out the effects of the sales tax hike, the consumer inflation stood at 0.5 percent in December.

"Reporters will no doubt ask Kuroda what his outlook for achieving the target in 2016 is looking like," said Bank of America Merrill Lynch economist Masayuki Kichikawa.

Forces beyond control

Analysts say a fundamental problem for the BOJ is that achieving the inflation targets depends on forces over which it has little control: oil prices and wages, which are important components in the central bank's benchmark core CPI index.

The BOJ's current CPI forecasts assume that oil prices, which staged a spectacular fall since June last year, have bottomed and will rise moderately going forward. But if oil prices continue to fall in the coming months, Kichikawa says that would be one trigger for further BOJ stimulus.

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Market watchers are also closely monitoring the annual wage negotiations between companies and unions. With many major Japanese firms reporting record earnings, union leaders are pushing for sizable pay rises. Rising wages is widely considered a necessity to get consumers spending, and eventually boost the inflation rate.

"We believe the Bank of Japan will maintain the current monetary easing over the near term unless annual wage negotiations between companies and unions prove unsuccessful and the economy shows any signs of contracting," says Harumi Taguchi, principal economist at IHS Global Insight.

Monday's GDP data showed wages rising just 0.1 percent in the fourth quarter, which translates to a fall of 1 percent in the whole of 2014, according to calculations by Credit Suisse Japan Economist Hiromichi Shirakawa.

Markets are expecting for wages to rise by at least 1 percent. Any figure "significantly" weaker than 1 percent could force the BOJ's hand to take more action, said BofA Merrill's Kichikawa.