Exclusive-BOJ leaning toward keeping rates steady next week, sources say

By Leika Kihara

TOKYO (Reuters) - The Bank of Japan is leaning toward keeping interest rates steady next week as policymakers prefer to spend more time scrutinising overseas risks and clues on next year's wage outlook, said five sources familiar with its thinking.

Any such decision will heighten the chance of an interest rate hike at the central bank's subsequent meeting in January or March, when there will be more information on the extent to which wage hikes will broaden next year.

There is no consensus within the central bank on the final decision, with some in the board still believing Japan has met the conditions for raising rates in December, the sources said. The decision will depend on the conviction each board member holds on the likelihood of Japan achieving sustained, wage-driven price rises.

There is also a slim chance the board may favour acting if upcoming events, such as the U.S. Federal Reserve's rate-setting meeting that concludes hours before that of the BOJ, trigger a renewed yen plunge that heightens inflationary pressure.

But overall, many BOJ policymakers appear in no rush to pull the trigger with little risk of inflation overshooting despite Japan's still near-zero borrowing costs, they said.

"Japan isn't in a situation where imminent rate hikes are needed," one of the sources said. "With inflation benign, it can afford to spend time scrutinising various data," another source said, a view echoed by two more sources.

The BOJ will hold its final policy meeting for the year on Dec. 18-19, when the nine-member board will deliberate whether to raise short-term interest rates from the current 0.25%.

Just over a half of economists polled by Reuters last month expect the BOJ to raise rates in December. About 90% forecast the BOJ to have hiked rates to 0.5% by end-March.

By contrast, markets are currently pricing in less than a 30% probability of a rate increase in December.

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The central bank has been guarded on the timing of the next rate hike, causing market expectations of a move to fluctuate between December and January.

There is growing conviction within the BOJ that conditions for another hike are falling into place with the economy growing moderately, wages rising steadily and inflation exceeding its 2% target for well over two years, the sources said.

In a sign of its confidence over the economic outlook, the central bank is likely to maintain its view that consumption is "increasing moderately as a trend," they said.

But there is no sense of urgency to hike as inflationary pressure from raw material imports has subsided due to the yen's recent rebound. That contrasts with when the BOJ hiked rates to 0.25% in July, when the currency's rapid fall pushed up import prices and heightened the risk of an inflation overshoot.

While rising wages are prodding more firms to hike services prices, such moves have not heightened enough to cause an alarming wage-inflation spiral, the sources said.

Acting in December, rather than January, could give markets the impression the BOJ is in a rush to push up rates to levels deemed neutral to the economy - something it wants to avoid.

The government, which still considers Japan as remaining in economic stagnation, also prefers the BOJ to move cautiously.

"It's desirable for the BOJ to hold off on raising rates until the economy recovers a bit more," a senior government official told Reuters, when asked about the December meeting.

Unless a renewed, rapid yen fall heightens inflationary pressure, many BOJ policymakers likely prefer awaiting information on whether firms will keep offering bumper pay hikes in next year's wage negotiations with unions, the sources said.

Holding until the Jan. 23-24 meeting would allow the BOJ to scrutinise remarks from corporate executives on next year's wage outlook, and its quarterly regional report that includes information on how smaller firms are setting prices and wages.

Another incentive to hold fire is uncertainty over U.S. president-elect Donald Trump's economic policies, which Governor Kazuo Ueda highlighted as a risk in a recent media interview.

"The biggest risk for Japan's economy comes from overseas," as sluggish global demand could hurt corporate profits and dampen their appetite to hike pay, a third source said.

The BOJ's decision next week will come hours after that of the Fed, which is widely seen cutting rates.

If the Fed surprises by holding rates and triggers a dollar surge, that could pressure the BOJ to hike rates to slow any sharp yen selloff, the sources said.

The BOJ ended negative interest rates in March and raised its short-term policy target to 0.25% in July. It has signaled readiness to hike again if wages and prices move as projected, and heighten conviction Japan will durably hit 2% inflation.

(Reporting by Leika Kihara, additional reporting by Takahiko Wada, Yoshifumi Takemoto, Kentaro Sugiyama and Takaya Yamaguchi; Editing by Sam Holmes)