BOJ May Scrap 0.1% Rate Floor, Pledge Open-Ended Asset Buying

Bank of Japan headquarters seen from an opposite building in Tokyo, Japan.
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Bank of Japan headquarters seen from an opposite building in Tokyo, Japan.

The Bank of Japan will next week mull scrapping its 0.1 percent floor on short-term interest rates and pledging to buy assets open-endedly until 2 percent inflation is foreseen, sources familiar with the central bank's thinking said.

Such steps would surprise the markets, which have been expecting the central bank to settle on the more conventional step of topping up its asset-buying and lending program by another 10 trillion yen ($113 billion).

Under relentless pressure from Prime Minister Shinzo Abe for bolder steps to beat deflation, the central bank is likely to double its inflation target to 2 percentand consider expanding monetary stimulus again at its two-day rate review that ends next Tuesday, sources told Reuters last week.

Instead of topping up the asset-buying and lending program again, the BOJ may pledge to buy assets open-endedly until 2 percent inflation is in sight, without setting a specific date for completing the purchases, the sources said.

Another idea being floated is for the central bank to pledge that it will keep the balance of its asset-buying and lending programme intact even beyond its end-2013 deadline, they said.

(Read More: Abe Unveils Stimulus - Don't Get Too Excited Yet)

The BOJ will also consider scrapping the 0.1 percent interest it pays on excess reserves that financial institutions park at the central bank, according to the sources, who spoke on condition of anonymity due to the sensitivity of the matter. That rate has effectively served as a floor to money market rates and kept them from falling to zero.

The BOJ set a 1 percent inflation target in February last year and eased monetary policy five times in the year, including in December, via increases in its asset-buying and lending program. It now pledges to pump 101 trillion yen to markets through the program, which serves as its key monetary easing tool, by the end of this year.

Markets have largely priced in a 2 percent inflation target and a 10 trillion yen increase in the BOJ's asset purchases next week, leading to calls within the central bank that it will have to try other new steps to maximise the impact on markets.

BOJ board member Koji Ishida last December proposed scrapping the 0.1 percent floor the bank sets on short-term interest rates, a move Governor Masaaki Shirakawa has opposed.

While the proposal was rejected in an 8-1 vote, another board member, Sayuri Shirai, said in a recent speech that the idea was worth considering as a way to further push down interest rates and help weaken the yen.

At Tuesday's policy meeting, the BOJ is also likely to issue a joint statement with the government pledging to pursue aggressive easing to achieve the new 2 percent inflation target.

Central bank and government officials are negotiating the wording for the statement, although they remain divided over how to phrase the time frame for achieving the target.

Abe wants the statement to clarify that the new target is a medium- and not long-term one that must be achieved in about two to three years, sources close to him say.

But the BOJ is opposed to setting a binding deadline for achieving 2 percent inflation, arguing that monetary policy alone cannot nudge up price growth to such a level in a country mired in deflation for most of the past two decades.

Shirakawa will meet with Finance Minister Taro Aso and Economics Minister Akira Amari on Friday to narrow their differences over the statement, a government source told Reuters.

The two cabinet ministers will then fine-tune the statement with Abe once he returns from his trip to Southeast Asian countries on Saturday, according to the source.