PREVIEW-BOJ leaning towards easing policy but board split

(For more stories on the Japanese economy, click [ID:nECONJP])

* What: Two-day Bank of Japan policy-setting meeting

* When: Outcome expected March 17, 0330-0500 GMT

* Reuters forecast: Rates steady at 0.1 pct, may expand fund supply

By Leika Kihara

TOKYO, March 15 (Reuters) - The Bank of Japan is leaning towards easing monetary policy again this week under pressure from a government calling for action to beat deflation, sources said, but the board is split on how to justify the move.

Since the economy is picking up, many of the seven board members are leaving their options open as they struggle to justify acting now. Disagreement may result in a split vote, or a delay in action until April.

Here are some possible outcomes:

LOOSEN POLICY THIS WEEK

Probability: More likely

Financial markets have largely factored in that the Bank of Japan will ease policy again but there are some doubts as to whether it will move this week or in April.

This week seems more likely.

The BOJ is leaning towards expanding or extending a funding operation put in place at an emergency meeting in December. With a pool of 10 trillion yen ($110.4 billion), it offers three-month loans to commercial banks at the policy rate of 0.1 percent.

That pool of funds might be doubled to 20 trillion yen, or the loan period might be extended to six months.

The central bank may feel little choice but to ease policy this week since government pressure is escalating and markets have already factored in an easing.

It would also make sense to move this month rather than in April because it will help fill a hole of around 6 trillion yen left when an emergency lending facility expires in March. The facility was put in place in December 2008 during the global credit crunch to help ease corporate funding strains.

Market impact: Money market rates and the shorter end of the yield curve have already fallen on expectations of a BOJ easing, so any further price action may be limited. Such expectations have also weakened the yen against the dollar. Expanding the duration of loans will have a bigger impact on the yield curve than simply expanding the size of the operation, as it would show the BOJ's stance of directly influencing yields, analysts say.

PUT OFF EASING UNTIL APRIL

Probability: Less likely

For now, the BOJ policy-setting board is split on easing policy. If those disagreements can't be overcome in the next few days, a policy decision may wait until April 6-7, when the next policy meeting is scheduled.

At the heart of the split is disagreement over how to justify easing policy now. The economy is moving in line with the BOJ's long-term forecasts and the yen is relatively stable. Indeed, it has been trending lower against the dollar in the past week.

BOJ officials acknowledge that expanding the fund supply operation won't give the economy an immediate boost.

So, easing policy will really be aimed at lifting household and corporate sentiment by showing the BOJ's determination to fight deflation.

If so, it would then make more sense to wait for the BOJ's tankan quarterly business sentiment survey due on April 1 to get the latest snapshot of how Japanese companies are doing and so the best gauge of how much additional monetary policy easing may be warranted.

Acting now may further reduce the BOJ's already shortening list of policy options. There is also no guarantee that loosening policy will shield it from government pressure for yet more aggressive action later on. It's just over three months since the BOJ loosened policy on Dec. 1 following government pressure.

Market reaction: Stock prices will fall, bond yields will rise and the yen may gain as traders unwind bets they built up on speculation of a BOJ easing.

BUY MORE GOVT BONDS, REVERT TO QUANTITATIVE EASING

Probability: Unlikely

The BOJ wants to avoid increasing the 21.6 trillion yen in government bonds it already buys for fear of sparking speculation that it will print money to pay for the government's spending. That could send government bonds tumbling.

Instead, BOJ officials say the only way to keep bond yields stable is for the government to come up with a credible plan to rein in Japan's huge public debt, which is set to reach 200 percent of GDP.

BOJ Governor Masaaki Shirakawa has also ruled out a return to full-blown quantitative easing, a policy targeting the amount of liquidity in the market and implemented between 2001 and 2006. It concluded the policy had limited affect in boosting prices. [ID:nTOE62B065]

It may shift to these aggressive measures if the yen or bond yields shoot up. But markets are relatively stable now, so it hopes to save these options for the future, such as if it comes under further government pressure.

Market reaction: More bond buying would be a surprise and would push down the yen and the longer end of the yield curve. But the effect would be short-lived if the BOJ sticks to its current stance of focusing its purchases on bonds close to maturity. ($1=90.54 Yen)