The Bank of Japan may decide to start withdrawing support for corporate finance on Wednesday, despite government criticism, at a policy meeting that may set the tone for its relationship with the new government.
The outcome of the two-day meeting has few implications for the corporate finance market, which has recovered from the shock of the financial crisis triggered by the collapse of Lehman Brothers last year.
But it will signal that the Bank of Japan, like its central bank peers in other major economies, wants to start edging monetary policy back toward more normal settings, as it judges that the credit and money markets have returned to normal and no longer need central bank help.
Analysts expect the BOJ to first scrap its buying of commercial paper and corporate bonds from banks, although some market players speculate the BOJ may also end low-interest loans made against corporate debt collateral.
But it would do so in the face of government pressure. Finance Minister Hirohisa Fujii said last week the BOJ should appropriately monitor corporate funding and expressed concerns that the economy was still unstable, though he backtracked later in the week, saying the issue was for the BOJ to decide.
One of his deputies told Reuters in an interview on Wednesday that the government wouldn't request a delay in voting if the Bank of Japan were to decide to end its buying of corporate debt.
For us to ask for a delay in a vote (on ending corporate debt buying) the finance minister and people under him would need to discuss lots of things, but no such thing has happened in advance, said Naoki Minezaki, one of the government's two senior vice finance ministers.
That means the government will leave it up to the BOJ's own judgment.
But outspoken banking minister Shizuka Kamei, who heads a small coalition party in the government, has spoken openly against any wind back in funding support.
Kamei told Reuters on Wednesday that the central bank should keep a close eye on the economy when examining ending its corporate financing support.
It needs to carefully watch the impact its decisions have on the economy, he said.
Analysts see credibility issues for a central bank that is officially independent if it were to bow to government pressure.
I wouldn't expect any major market reactions. But of course that would undermine the credibility of the BOJ, said Junko Nishioka, chief Japan economist at RBS.
The BOJ is almost certain to keep interest rates on hold.
Annual wholesale price falls narrowed in September from a record drop in August, but economists expect deflation to persist due to weak demand, giving the BOJ an added incentive to keep interest rates near zero for some time.
MARKETS BACK IN ACTION
Debt issuance has come back to life and credit spreads have shrunk considerably since the BOJ introduced the funding support in the middle of the financial crisis that drove scared investors out of the market.
Corporate debt issuance hit a record high 2.29 trillion yen ($25.5 billion) in June, a sea change from late last year when there were no corporate bond issues for nearly a month.
The cost to insure a basket of Japanese companies' debt with credit default swaps has shrunk to around 115 basis points from its peak of 550 basis points in March.
For a graphic on credit conditions, click on http://r.reuters.com/sew63f
The rate for new commercial paper has occasionally fallen below that of government debt, raising concerns that its purchase is not so much helping the market as distorting it.
Although Japan's economy crawled out of its recession in the second quarter after a year of sharp contraction, the government is worried about rising unemployment, particularly among small firms that employ about 70 percent of the country's workforce.
Still, the government is unlikely to wield its power to ask the BOJ to delay policy decisions at the meeting, as Prime Minister Yukio Hatoyama's ruling Democratic Party of Japan has said it will respect the central bank's independence.
Government representatives who take part in the BOJ's policy meetings can ask for a delay in decisions until the next gathering, but the BOJ does not have to agree to such a request.
It has only asked for this to happen once -- in 2000, just two years after the BOJ was given greater independence -- and the board ignored the request and raised rates, only to have to lower them soon after as the economy took a turn for the worse.
As the incident tarnished the image of both the government and the Bank of Japan, government and central bank officials are keen to avoid a standoff.
The Bank of Japan is expected to say it will continue to focus on downside risks to the economy for the time being, a signal that interest rates will be kept near zero for a long time even after the withdrawal of emergency stimulus measures.
If no agreement is reached on the emergency funding support measures this time, the BOJ will have to decide on the emergency steps at its next meeting on October 30 or the following one on November 19-20 to avoid last-minute decision ahead of their expiry at the end of the year.
(Additional reporting by Stanley White; Editing by Hugh Lawson)