Bank of Japan policymakers will likely debate the possibility of easing monetary policy further at a rate review this month, as a raft of gloomy data threatens their scenario that a moderate economic recovery will accelerate inflation towards a 2 percent target, sources familiar with their thinking said.
If the central bank were to act, it would more likely increase asset purchases than cut interest rates, the sources said, as financial institutions are still scrambling to adjust to a negative rate policy deployed in January.
But a decision on whether to ease at the April 27-28 review will be a close call as many BOJ officials are wary of using their limited policy tools again so soon, especially as the negative rate move has proved unpopular among the public.
"It will be a question of whether the BOJ feels it has forestalled risks in January or whether they feel that January's action wasn't enough," said one of the people familiar with the BOJ's thinking.
The BOJ stunned markets in January by adding negative interest rates to its massive asset-buying program, dubbed "quantitative and qualitative easing," to forestall the risk of external headwinds derailing a fragile economic recovery.
But the move failed to boost stock prices or arrest an unwelcome yen rise, drawing criticism from lawmakers and investors as confusing rather than calming markets.
A slew of weak data has since kept the BOJ on edge.
Business sentiment soured and corporate inflation expectations weakened in January-March, the BOJ's "tankan" survey showed, casting doubt on the bank's argument that aggressive money printing will prompt firms to boost spending in anticipation of future price rises.
Japanese stock prices have slumped on investors' concerns that sluggish emerging market demand and the yen's rebound will hurt corporate profits, threatening to undermine the BOJ's efforts to brighten public sentiment with bold monetary action.
BOJ Governor Haruhiko Kuroda has insisted that Japan's economic recovery remains intact, and blamed sharp declines in oil prices for keeping inflation roughly flat.
While many BOJ officials agree with Kuroda that Japan's fundamentals remain solid, some worry the economy is losing the momentum needed to push up inflation as weak exports and household spending threaten to tip Japan into recession.
Sources have told Reuters that the BOJ is likely to slash its inflation forecasts in a quarterly review to be conducted at the April meeting, and push back the timing for hitting its 2 percent target.
That will heighten pressure on the BOJ to ease again.
But many board members are hesitant of doing so now, with some openly questioning the merits of pushing down already low borrowing costs with unconventional policy steps.
Kuroda told parliament on Tuesday that financial market moves would be among key factors in deciding whether to act, suggesting the likelihood of an April easing may depend on how the yen and stock prices perform ahead of the meeting.
"We need to take a comprehensive look at various factors in deciding (the best mix of steps) at the time, including market moves, particularly those in Japan," Kuroda said.