The Bank of Japan is likely to ease monetary policy on Friday by boosting asset purchases by up to 10 trillion yen ($123 billion) and in doing so may extend the maturity of government bonds it targets to around three years, according to sources familiar with the central bank's thinking.
The action, which would be the central bank's second easing in just over two months, would serve to show the BOJ's determination to overcome deflation and reach the 1 percent inflation target adopted at its February meeting.
The central bank has been under constant pressure from politicians to do more to rev up the world's third biggest economy, and BOJ policymakers have signalled their readiness to provide more stimulus.
But there is no consensus yet within the central bank on whether it should increase its 30 trillion yen asset-buying program by the usual 5 trillion yen increment, or by double that amount - as it did in February - for greater market effect.
If it were to opt for a bigger increase, the BOJ may also extend the maturity of government bonds it buys under the program to around three years from the current two-year duration, said the sources who spoke on condition of anonymity.
What appears to be certain is that the BOJ will ease on Friday. But there seems to be various views on by how much, so that will be a close call, one of the sources said.
The BOJ now pledges to meet the 30 trillion yen target for asset purchases by the end of this year, but may extend that deadline by about six months if it were to boost the program, the sources said.
With interest rates virtually at zero, the BOJ has adopted as its main policy tool a program under which it buys assets ranging from government bonds to corporate debt and trust funds investing in property and shares.
Any expansion in the program would come mainly in the form of government bonds, although there is a slim chance the BOJ may also pledge to buy more exchange-traded funds (ETFs) depending on the size of increase, the sources said.
NO CONSENSUS YET ON SIZE
The central bank's policy action in February helped weaken the yen and lift stocks as markets took it as a sign of greater determination to battle deflation, which has plagued Japan for more than a decade.
But Japanese lawmakers have continued to pile pressure on the BOJ as the yen remains near levels that threaten exporters' profits and consumer prices are barely rising.
BOJ Governor Masaaki Shirakawa, who highlighted the risks of keeping policy too loose for too long, is seen reluctant to add a big amount of bonds to the asset-buying program or extend their duration now.
Prospects of a moderate economic recovery may help him persuade the board to save ammunition for now and go with just a 5 trillion yen increase in asset purchases.
But others, such as Deputy Governor Kiyohiko Nishimura, appear ready for another big step. Concern that renewed jitters over Europe's debt crisis could spark another yen rally may convince pessimists to opt for a 10 trillion yen increase.
That, however, would mean the BOJ would need to buy 25 trillion yen more assets by the end of 2012. That is no easy task with two-year bond yields stuck at 0.1 percent and some auctions failing to draw enough bids.
The central bank may thus target bonds with longer maturity than the current two years and extend the deadline for achieving the target by six months, sources say.
That would allow it to maintain the pace of bond purchases at 1.5 trillion yen per month and signal its commitment to keep monetary conditions ultra-loose for an extended period.
In debating the size of increase in asset purchases, the BOJ board will also take into account the outcome of the Federal Reserve's policy meeting on Tuesday and Wednesday.
No new steps are expected, but any mention of more stimulus could nudge the dollar lower against the yen.
On Friday, the BOJ will also publish revised economic projections for up to the fiscal year ending in March 2014.
The BOJ is likely to keep its growth forecasts roughly unchanged and slightly raise its consumer price estimates from three months ago, when it projected 0.1 percent inflation for the current fiscal year, which began April 1, and 0.5 percent for the following year.
Still, the new price forecasts will likely show that 1 percent inflation is still some distance away, giving the BOJ justification to ease policy now, analysts say.
The BOJ is unlikely to raise its inflation target to 2 percent now, a move some lawmakers have called for, but may signal in its semiannual report that even if 1 percent inflation comes into sight, the central bank will not immediately reverse its ultra-easy policy stance.
($1 = 81.0750 Japanese yen)
(Additional reporting by Sumio Ito and Yoshifumi Takemoto; Editing by Tomasz Janowski, Joseph Radford and Richard Borsuk)