Is the Bank of Japan Backtracking on Its Inflation Pledge?

Haruhiko Kuroda, governor of the Bank of Japan
Tomohiro Ohsumi | Bloomberg | Getty Images
Haruhiko Kuroda, governor of the Bank of Japan

The Bank of Japan's (BOJ) latest economic forecasts suggest it is likely to achieve its 2 percent inflation target later rather than sooner – a dose of realism that is good for its credibility and needed to temper market expectations, analysts said.

The BOJ shocked markets in early April by announcing that it would pump $1.4 trillion into the economy to meet a 2 percent inflation target in about two years.

But in its semi-annual economic report on Friday, the BOJ forecast core consumer inflation, the measure the central bank prefers to follow as a gauge of prices, to take slightly longer to rise to 2 percent.

It now expects consumer price inflation to hit 1.9 percent in the year starting April 2015, while the 2 percent inflation target will be achieved by the end of the following fiscal year.

"Taking a realistic view is always better than it is bad, because even if you gloss over things short-term cracks can always appear," said Mizuho Corporate Bank's market economist Vishnu Varathan.

"So it's a good thing that they're suggesting the inflation target may not be met within two years. I like how there was some uncertainty injected because that reflects the real world," he added.

Financial markets reacted to the BOJ's latest forecasts by giving the battered Japanese yen a reprieve. The yen, which has fallen more than 20 percent against the U.S. dollar since November on expectations for aggressive monetary stimulus in Japan, hit its highest level in more than a week on Monday.

(Read More: Has the Dollar-Yen Topped Out Already?)

"With BOJ officials skeptical about their own ability to boost inflation to 2 percent, it is no surprise to see dollar/yen under pressure," said Kathy Lien, managing director at BK Asset Management, in a note.

Many economists have questioned whether the BOJ, which set a 2 percent inflation target in January, would be able to achieve that goal in two years. Deflation, or falling prices, has dogged Japan for two decades and breaking out of that cycle is not going to be easy, they argue.

In fact, data on Friday showing that consumer prices in Japan fell for a fifth straight month in March highlighted just how tough the battle against deflation is.

"I don't believe Japan will get anywhere close to its 2 percent inflation target in the next two years, I think three-to-four years is a more realistic timescale," said Nizam Idris, head of strategy for fixed income and currencies at Macquarie Bank.

(Read More: Consumer Prices in Japan Fall for Fifth Straight Month)

Divided They Stand

Inflation estimates from the BOJ's board members ranged widely, in a sign of disagreement on the BOJ board over when the inflation target will be met. For the 2015 fiscal year for instance, the policy board's forecasts ranged from 0.8 percent to 2.3 percent.

"It appears that some policy board members are skeptical that Japan will see 1 percent inflation, let alone the 2 percent target, during the forecast horizon," HSBC said in a note.

Analysts said that by suggesting the inflation goal may not be met in two years, the BOJ was giving itself room to step up monetary stimulus if necessary as well as putting pressure on the government to do what it can to help end deflation.

"For the BOJ to admit there are things that are out of its locus of control is a good thing as it means that implicitly they are putting pressure on the government to make economic reforms," said Mizuho's Varathan. "It also leaves them room to do more on the monetary policy front if they need to."

- By CNBC.Com's Dhara Ranasinghe; Follow her on Twitter @DharaCNBC