Bank of Japan Governor Masaaki Shirakawa said on Thursday that solid growth in emerging markets will continue to underpin Japan's economy, suggesting the central bank will stick to its forecast of a moderate recovery when its board meets next week.
But he reiterated that the BOJ will act appropriately by closely monitoring the economic and price outlook, a sign the central bank is ready to ease monetary policy further if risks from abroad threaten to stall the upturn.
One concern for the Japanese authorities is that the yen's persistent strength, driven by investors' flight to the safety of liquid, low-risk assets, will choke off one vital source of economic growth -- exports.
Such worries spurred plans for a joint government-central bank task force that will monitor and coordinate steps aimed at tackling the yen's strength and helping to cushion its economic impact, according to a draft plan obtained by Reuters.
For now, the central bank is sticking to its guns, predicting a gradual pickup from a slump that followed the March 11 earthquake and tsunami.
Overseas growth will slow for the time being but will be firm as a trend mainly in emerging economies, Shirakawa told a quarterly meeting of the BOJ's regional branch managers.
Japan's economy will resume a moderate recovery as exports increase moderately as a trend, and as companies spend to restore plant and equipment damaged by the disaster, he said.
Europe's festering debt crisis, the global economic slowdown and the yen's strength have cast doubts over the BOJ's forecast for a moderate economic recovery backed by solid global demand.
But Shirakawa's insistence that the economy was on the mend just a week before central bank rate review on October 27 suggests that it will make no big changes to its recovery scenario in a twice-yearly outlook report due on the same day.
That heightens the chance the BOJ will hold off on easing policy further next week, unless a Sunday meeting of euro zone leaders disappoints markets enough to trigger a sharp fall in global stocks and a surge in demand for the safe-haven yen.
The BOJ is seen cutting its economic forecasts for the current fiscal year ending in March 2012 and the following year in its twice-yearly outlook report, reflecting the impact of the global slowdown, sources familiar with the bank's thinking said.
In the latest forecast issued in July, the BOJ expected Japan's economy to expand 0.4 percent in the current fiscal year and 2.9 percent in the following year ending in March 2013.
A Reuters poll showed economists now expect growth of 0.2 percent in the current fiscal year and a 2.2 percent increase in the following year. The central bank's new forecasts will likely be roughly in line with such private-sector projections.
The government downgraded its assessment earlier this week, saying that even though the economy continued to recover its pace has slowed.
The BOJ is likely to send a similar message, trimming forecasts but stressing that the economy was still picking up, a view backed by a quarterly report on regional economies.
The report, compiled by BOJ branch managers, raised its assessment for five regional economies and maintained its view on four.
But not all were optimistic about the outlook, with some regions, such as the Kinki region that is home to big electronic makers like Panasonic Corp <6752.T>, saying that the global slowdown was starting to dent output.
Exports and output are stalling or somewhat falling. The strong yen is playing some part in this but the effect is more from the overseas slowdown, Hideo Hayakawa, branch manager for Osaka in western Japan, told reporters.
There's clearly a sense that uncertainty over the outlook is broadening.
Panasonic will reduce plasma TV panel production and lay off about 1,000 people as its loss-making television unit struggles to compete with Asian rivals, a source told Reuters on Thursday.
Shirakawa also said Japan's banking system remained stable as a whole, with domestic financial institutions facing no trouble raising funds despite jittery global markets.
But the central bank will watch for risks, such as the chance of financial institutions incurring huge losses on securities holdings due to market turmoil, he said.
The central bank has kept monetary policy on hold since easing in August, when it increased asset purchases to ease the pain from a strong yen on the export-reliant economy.
(Additional reporting by Shinji Kitamura; Editing by Tomasz Janowski)