TOKYO (Reuters) - The Bank of Japan is expected to hold off on easing monetary policy next week but is gearing up for further action in October as the strong yen threatens to derail its forecast of a moderate economic recovery, sources said.
Having just loosened policy at an emergency meeting on Monday, the central bank is likely to stand pat at next week's rate review unless the yen shoots up at a pace of 1 to 2 percent in a single day after Friday's U.S. payrolls data for August.
If such sharp yen gains trigger yen-selling intervention by the finance ministry the BOJ is ready to leave it unsterilized, effectively easing policy by holding off from draining the extra yen that flows out to the market, sources familiar with the central bank's thinking said.
Otherwise, the BOJ is in no mood to ease policy further in September and is lining up its options for next month, when it is seen revising down its long-term economic and price forecasts in a semiannual outlook report due on October 28.
"Things have changed so much in the past few months, so we probably need to reconsider our forecasts, especially our price projections," one of the sources said.
"If we can't foresee positive price growth for years, it's hard to justify standing pat." Another source expressed a similar view. Both declined to be named due to the sensitivity of the matter.
There is no consensus yet on what the next step should be, but the list of options include a return to zero interest rates or an increase in the bank's government bond purchases.
The BOJ boosted its cheap loan scheme on Monday, bowing to government pressure for steps to protect a fragile recovery after the yen surged to a 15-year high against the dollar last week.
But the move did little to deter yen gains or falls in stock prices as investors saw it as a symbolic gesture that had barely any effect in supporting the economy and beating deflation.
That has led some BOJ officials to believe that bolder action is needed to send a clearer message to markets that the bank is determined to keep the strong yen from harming the economy.
Still, the BOJ is likely to hold off easing policy at the next rate review on September 6-7 to examine how Monday's decision to expand its fund supply tool will affect markets and fund flows.
Unless the yen heads toward its all-time high beyond 80 to the dollar at an alarming pace, the central bank hopes to spend more time examining the impact of market moves on the economy.
It sees its tankan quarterly business sentiment survey, due out on September 29, as crucial in measuring the strong yen's impact on the economy.
The BOJ may consider easing policy when it issues its outlook on October 28, or at a policy meeting due three weeks before that, if there is sufficient evidence that the yen's rise and a U.S. economic slowdown are damaging business sentiment enough to warrant action, the sources said.
Japan's economic growth slowed to a crawl in the second quarter, and analysts expect a further slowdown later this year as exports to the United States and China ebb and stimulus-driven consumption peters out.
The BOJ has also remained under government pressure to ease policy, but the outlook is being complicated by ruling Democratic Party powerbroker Ichiro Ozawa's decision to challenge Prime Minister Naoto Kan in a September 14 party leadership vote.
Ozawa has threatened to intervene in currency markets to curb the yen's rapid rise while saying that policy options for the BOJ are limited.
(Editing by Edmund Klamann & Kazunori Takada)