UPDATE 1-BOJ's Iwata signals chance of tapering if economy overheats

Mon May 26, 2014 4:23am EDT

* BOJ's QQE prevents not just deflation but excessive inflation-Iwata

* Adds rising inflation expectations help prevent sharp yen gains

* Govt must not delay structural reforms to boost growth potential (Adds quotes, details)

By Leika Kihara

TOKYO, May 26 (Reuters) - Bank of Japan Deputy Governor Kikuo Iwata signalled on Monday the possibility of withdrawing the central bank's massive monetary stimulus if the economy overheats and nudges up inflation well above its 2 percent price target.

Iwata voiced confidence that Japan was making steady progress in meeting the central bank's inflation goal with prices rising not just because of a weak yen, which inflates import costs, but strength in domestic demand.

He also said heightening inflation expectations in Japan would help prevent excessive rises in the yen, which had weighed on the export-reliant economy during 15 years of deflation.

While he stressed the BOJ's resolve to maintain ultra-loose monetary conditions for as long as needed to beat deflation, Iwata said the central bank's current stimulus programme also aims to prevent excessive inflation.

"The BOJ's current policy intends to prevent not just deflation but inflation from well exceeding 2 percent, such as to 4 percent or 5 percent, for a medium- to long-term period," Iwata told a seminar.

"If the economy overheats and inflation exceeds 2 percent on a permanent basis, we will adjust policy," he said. "On the other hand, if our price goal is distant and prices don't seem to be approaching the target, we will adjust policy the other way" by expanding stimulus, he added.

Since deploying its "quantitative and qualitative easing" (QQE) programme in April last year, the BOJ has remained silent on when it could consider withdrawing the stimulus for fear of diluting its message that it is determined to end nearly two decades of economic stagnation.

Iwata's comments, the first from a senior BOJ official directly mentioning the chance of withdrawing QQE, reflects the growing confidence within the central bank that Japan is winning the battle against deflation.

The BOJ has repeatedly said the economy is recovering strongly enough for consumer inflation to hit its 2 percent target by around April next year, when its two-year time frame for meeting the goal expires.

While core consumer inflation has reached 1.3 percent in March, market players remain sceptical on whether price gains will accelerate from here as quickly as the BOJ predicts.

Still, the BOJ's optimistic view of the economy and prices have led market players to scale back expectations of imminent monetary easing.

Iwata said that while the BOJ will support the economy by stimulating demand, it was the government's job to boost Japan's long-term growth potential by implementing structural reforms.

Economic growth will remain subdued even if the BOJ achieves its price target, unless the government proceeds with structural reforms, he warned. (Additional reporting by Stanley White; Editing by Chris Gallagher and Jacqueline Wong)

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