UPDATE 1-BOJ's Iwata warns of deflation risk if inflation stays below 1 pct

Mon Mar 24, 2014 4:18am EDT

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By Leika Kihara

KITA-KYUSHU, Japan, March 24 (Reuters) - Bank of Japan Deputy Governor Kikuo Iwata warned on Monday that inflation staying below 1 percent for a long period of time was "dangerous" as it heightened the risk of deflation.

That is why the BOJ set a price target of 2 percent, a level deemed ambitious in a country mired in deflation for 15 years, and pledged to achieve it in roughly two years when it deployed an aggressive stimulus programme in April last year, Iwata said.

"We're not saying the price target must be met strictly in two years," Iwata said.

"By setting a timeframe, we showed markets our determination to achieve the target," he said in a seminar in the southern Japanese city of Kita-Kyushu on Monday.

Fears of Japan-style deflation have been a major talking point in the euro zone, where inflation has been in what the European Central Bank calls the "danger zone" below 1 percent for the past few months. The ECB has said there is no risk of deflation because inflation expectations are well-anchored.

Iwata, speaking of Japan's experience, said deflation becomes a problem when it lasts long enough to discourage households and companies from spending. It is also problematic because it heightens the value of the yen, hurting Japanese exports, he said.

"I'm not saying it's good for the yen to be high or low. I'm just saying it's not good for the yen to strengthen to the extent it leads to job and output losses. When that's happening, policymakers must act to stop it," Iwata said.

OVERALL WAGES KEY

The BOJ has kept monetary policy steady since deploying an intense burst of stimulus in April last year, when it pledged to double base money via aggressive asset purchases to accelerate consumer inflation to 2 percent in two years.

Iwata was upbeat about Japan's economic prospects, saying that companies will start to boost capital expenditure on optimism over the outlook. Exports will also pick up as global demand recovers, with the yen's declines already having boosted shipments, he said.

Iwata also dispelled speculation in markets that the BOJ will ease policy again soon to ease the pain from an increase in the sales tax in April.

"The BOJ, when it deployed the current (ultra-easy) monetary policy, took into account whether (the stimulus) was enough for the economy to recover after the slump," he said.

A Reuters poll showed markets expect the central bank to expand stimulus again by July, partly on the view that by then it will become clearer that wages won't rise enough for consumer inflation to reach 2 percent.

Japan's core consumer price index rose 1.3 percent in January and in December, which was the quickest gain since 1.9 percent in October 2008.

Prime Minister Shinzo Abe, in a rare move, has called on Japanese companies to raise base salaries -- something they have not done for years to rein in costs -- given many big export firms have reaped huge gains thanks to the weak yen.

While Iwata echoed hopes held by many policymakers that companies raise base salaries, he warned that some firms may not be able to do so given pressure to keep costs in check.

But that won't signal a failure of "Abenomics" -- a mix of aggressive fiscal and monetary stimulus steps as well as structural reforms to revive the economy -- as long as the amount households earn rise as a whole, he said.

"It would be nice if base salaries rise. But even if not, it's important that bonuses and overtime pay continue to rise in a sustained manner," Iwata said. (Reporting by Leika Kihara; Editing by Dominic Lau & Kim Coghill)

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