RPT-SCENARIOS-BOJ leaning toward exit from some emergency steps

(For more stories on the Japanese economy, click [ID:nECONJP]) (Repeats story that first ran on Wednesday)

By Leika Kihara

TOKYO Oct 28 (Reuters) - The Bank of Japan is leaning towards scrapping some corporate finance support programmes that expire in December, but it may put off a decision again this week in the face of government pressure.

The central bank is also expected to forecast three years of deflation in its twice-yearly economic outlook report, a sign it will keep interest rates near zero at least until 2011.

The BOJ deferred a decision on withdrawing fund support at its previous meeting on Oct. 13-14, after the government pressed it to consider the cost of its retreat from credit markets.

Here are possible outcomes of the meeting. A decision is expected some time between noon and 2:30 p.m. (0300-0530 GMT) on Friday.

--CORPORATE FUND SUPPORT--

BOJ SAYS TO END COMMERCIAL PAPER, CORPORATE BOND BUYING

Probability: High

The BOJ believes credit markets have improved enough to justify ending its commercial paper (CP) and corporate bond purchases when they expire in December.

The purchases helped push down the average rate of one-month CP to 0.21 percent in August, more than a full percentage point below 1.34 percent in December. Its CP buying auction on Oct. 23 drew no bids for three times in a row.

For a graphic on Japan's credit market improvements, click: here

Many BOJ officials think keeping the measures in place for too long would do more harm than good, with the CP issuance rate having fallen too low to attract investors.

MARKET IMPACT: Reaction may be muted as CP and corporate bond markets are not relying much on the BOJ purchases any more.

BOJ SAYS TO SCALE DOWN OR END LOW INTEREST RATE LOANS IN DEC

Probability: Medium

Many within the BOJ feel markets no longer need support from another step expiring in December -- a programme of lending to banks at 0.1 percent interest in exchange for collateral.

Shirakawa has signalled the programme may be replacable by regular market operations. But ending this popular operation will be far tricky than scrapping CP and corporate bond buying.

The board is split. Atsushi Mizuno, the most pessimistic board member on the economy, said earlier this month that ending it too hastily could destabilise markets. [ID:nT207831]

An exit also won't go down well with the government, which aims to introduce a bill to help debt-squeezed small firms with financing. [ID:nT375152]

Instead of ending the programme, the BOJ may scale it back partly, such as by reducing the number of market operations.

MARKET IMPACT: The programme has helped cap interbank rates so announcing an end to it may push up interbank lending rates, such as three-month rates.

BOJ PUTS OFF DECISION ON CORPORATE FUND SUPPORT

Probability: Medium

The BOJ feels the role of its corporate debt buying is diminishing. But some within the board are wavering over the timing of an exit, worried that corporate finance may tighten again toward the March 31 fiscal year-end.

Announcing an end to the steps now could risk heightening tension with the government, which frets about rising job losses and views the BOJ's economic assessment as too rosy.

Finance Minister Hirohisa Fujii renewed his complaint over the BOJ's view that the economy is getting better.[ID:nT285056]

The government doesn't appear to be preparing to request a delay in vote even if the BOJ moves to end the measures.

But with the board already struggling to reach a consensus, such vocal pressure may be enough for the BOJ to put off a decision until November.

MARKET IMPACT: After putting off a decision at the previous meeting following pressure from the government, another delay may cast doubts about the BOJ's independence and accelerate rises in long-term bond yields.

BOJ CAVES IN TO POLITICAL PRESSURE, HINT AT EXTENDING STEPS

Probability: Low

Although the BOJ steps are mostly aimed at larger firms, scrapping them could be seen as running counter to government plans to adopt a debt moratorium to help small firms.

To fend off criticism that the BOJ is not doing enough to support the economy, the bank has stressed that it will keep rates near zero regardless of the fate of the special steps.

But if government pressure persists, the BOJ may shift course and examine extending some measures beyond December.

Even so, the BOJ won't extend all the steps as that would give markets the impression the BOJ is yielding to pressure and doesn't have full control over monetary policy.

It may instead seek middle ground, such as by ending CP and corporate bond buying but extending the low-rate loan programme.

MARKET IMPACT: Any sign the BOJ is caving into pressure may cast doubts about its independence and push up bond yields.

--SEMIANNUAL REPORT--

BOJ FORECASTS 3 YEARS OF DEFLATION BUT SEES FALLS NARROWING

Probability: High

The BOJ is already forecasting two years of deflation and is set to extend that to three, effectively pledging to keep rates near zero at least until 2011. [ID:nT347265]

But it will predict price falls to narrow on the view that Japan's economy will recover as a trend on support from overseas growth, a rosier view than that of the government.

The bank will also revise down its estimate of Japan's potential growth rate, suggesting the country may pull out of deflation sooner than initially expected. [ID:nT214551]

Such assessment will serve as a basis for the BOJ to forgo taking additional monetary easing steps, at least for now.

MARKET IMPACT: Stock and bond markets will take it in stride as many participants already expect the BOJ to keep rates low. (Editing by Kazunori Takada)