The Bank of Japan will maintain its existing stimulus policy and optimistic economic view on when it meets on Thursday, sources say, preferring to take more time to gauge whether a run of weak data is sufficient to threaten a fragile recovery.
But signs of prolonged disruption from a sales tax hike in April are beginning to sap the conviction of many central bankers that the economy will rebound steadily from a severe second-quarter contraction caused by the higher levy.
While the BOJ is likely to stick to its assessment that the economy is recovering moderately, pessimists on the board may propose offering a bleaker view on components such as factory output, say sources familiar with the bank's thinking.
"It's pretty clear from data out so far that the economy is undershooting the BOJ's forecast," said Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute. "The rebound in July-September may prove to be much weaker than expected."
The BOJ cut its assessment on exports earlier this month to say they were "weakening" but left intact its view that factory output, while also weakening, continues to "rise as a trend".
That view may be subject to change after data on Friday showed July's factory output barely recovered from a steep fall in June, which was the biggest retreat since the March 2011 earthquake as weak sales left firms with huge inventories.
Household spending fell more than expected in July and analysts expect bad weather and lasting effects from the tax hike to weigh on consumption in coming months, casting doubt on the BOJ's view that domestic demand remains firm.
The recent run of weak data will be closely scrutinized at the BOJ's two-day rate review that ends on Thursday.
At the meeting, the bank is expected to leave unchanged its policy framework, under which it pledged to increase base money by 60-70 trillion yen ($578-674 billion) per year via aggressive asset purchases to reflate the long-moribund economy.
INFLATION VIEW INTACT
Japan's economy shrank at an annualized 6.8 percent in the second quarter, more than erasing a first-quarter surge in the run-up to the sales tax hike. Analysts polled by Reuters expect a 3.8 percent bounce this quarter.
The BOJ is likely to cut its economic growth projection for the current fiscal year when it reviews its long-term forecasts in October. But it still expects the economy to ride out the tax hike and recover strongly enough to meet its 2 percent inflation target sometime in the next fiscal year starting in April.
BOJ Governor Haruhiko Kuroda, unfazed by the second-quarter contraction, has stressed that the recovery remains intact and that Japan is making headway in meeting the price target. He is likely to stick to that message at a post-meeting briefing on Thursday, analysts say.
Sources have told Reuters that the BOJ is likely to keep its bullish price forecasts, which see consumer inflation nearing 2 percent next fiscal year, even as it cuts its economic growth forecast in October.
Behind the BOJ's optimism is a steady improvement in job and income conditions. The jobless rate is at levels the BOJ sees as near full employment and job availability is at a 22-year high.
Companies, after holding down wages for nearly two decades on prospects that deflation will persist, are gradually raising salaries and bonuses, offsetting some of the pressure on households from the sales tax hike.
There is also a practical reason for the BOJ to put a brave face. The key goal of its massive stimulus program is to lift public sentiment and make people believe that prices and wages will rise in coming months. Comments revealing concerns over the economic outlook may dampen sentiment and undermine the effect of the stimulus, BOJ officials say.
Still, the widening gap between Kuroda's upbeat tone and the pessimism spreading among private-sector analysts may dent the BOJ's credibility, particularly if upcoming data continues to disappoint, analysts say.
"The economy continues to undershoot the BOJ's forecast but the bank hasn't changed its bullish price forecasts. With the data so weak, it's becoming more and more difficult to explain why prices could keep rising even when growth is slow," said Izuru Kato, chief economist at Totan Research Institute.
"Kuroda probably thinks it's too early to give up (on meeting the target). But at some stage, he will either have to ease further or delay the timeframe for meeting the price goal."
Under its "quantitative and qualitative easing" scheme launched in April last year, the BOJ has pledged to engineer 2 percent inflation in roughly two years in a country mired in 15 years of deflation.
None of the analysts polled by Reuters expect the BOJ to meet the target within the two-year timeframe.
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