By Leika Kihara
TOKYO (Reuters) - A sluggish U.S. economy and tepid exports to emerging markets are sapping the Bank of Japan's confidence that a recovery in overseas markets will take up the economic slack in Japan when consumers are hit with a higher sales tax next year.
Only three months ago, the BOJ had expected global economic growth to pick up by early next year, in time to offset an expected downturn in household spending as the sales tax rises to 8 percent from 5 percent.
Now, many central bankers doubt the global economy will recover so soon, given a slowdown in emerging Asia and a lingering impact from the U.S. debt crisis, which could intensify once again early next year when Washington reaches its borrowing ceiling once again.
"Risks from overseas have heightened somewhat from three months ago, delaying a pick-up in the global economy," said a source familiar with the central bank's thinking.
That will temper the extent to which the BOJ might increase its long-term economic forecasts in a quarterly review at a policy meeting next week, said people familiar with the BOJ's thinking. The BOJ is widely expected to maintain its monetary policy stimulus at the review on October 31.
The central bank maintains that the Japanese economy can sustain a moderate recovery. At next week's meeting, the BOJ is expected to revise up economic growth for the fiscal year beginning in April 2014 to around 1.5 percent from the current 1.3 percent, said the sources, who declined to be identified.
The revision is based on a 5-trillion-yen ($51 billion) stimulus package planned by Prime Minister Shinzo Abe to offset the initial impact of the increase in the sales tax.
Analysts expect the stimulus package to add a maximum of 0.5 percentage point to growth.
Even optimists on the BOJ board see growing overseas risks. Among them, Deputy Governor Kikuo Iwata warned last week that weak Asian growth and uncertainty over the U.S. debt ceiling were key risks that could threaten the central bank's goal of achieving 2 percent inflation in two years.
Given the impact on inflation would take longer, some board members may revise up their fiscal 2015 core consumer inflation forecast, the sources said.
That could push up the central bank's median inflation forecast to 2 percent from the current 1.9 percent, effectively marking its first formal recognition that its official target of achieving 2 percent inflation in two years is within reach.
Still, the sources said a revision will be a close call, especially as inflation predictions by the nine members vary widely. Private-sector economists think BOJ inflation forecasts are very ambitious.
Even if the BOJ increases its projection to 2 percent, it will stress it is too early to debate a strategy for winding down its ultra-loose policy, which should wait until it is confident 2 percent inflation is sustainable, the sources said.
Japan's economy expanded for three straight quarters in April-June as the "Abenomics" stimulus policies boosted business sentiment and household spending. But analysts expect growth to slow markedly later this year as exports feel the pinch from slowing emerging market demand.
BIG GAP
Under its ultra-loose monetary policy, the BOJ plans to double base money by injecting roughly 7 trillion yen ($72 billion) into the economy each month to drive inflation to 2 percent in about two years.
BOJ Governor Haruhiko Kuroda has maintained the economy is steadily proceeding towards the central bank's price target. The BOJ raised its economic assessment on all of Japan's nine regional economies on Monday, saying for the first time since 2005 that all the regions were in recovery.
Core consumer prices rose in August by 0.8 percent from a year earlier, the highest level in nearly five years, raising hopes a budding economic recovery may finally end the deflation that has haunted the country for 15 years.
But analysts are not so optimistic, saying price gains are currently being driven largely by rising energy costs and raw material import prices, rather than a pick-up in domestic demand that would suggest more sustainable inflationary pressures.
A poll by Reuters showed analysts expect economic growth of 0.9 percent in fiscal 2014 and core consumer inflation of 0.9 percent in fiscal 2015, well below the BOJ's forecasts.
Some in the BOJ share the market's doubts. The range of the BOJ's latest forecasts, made in July, showed one board member projected core consumer inflation of 0.7 percent and another 0.9 percent. The highest forecast was for inflation of 2.3 percent, underscoring the difference in views within the board on how fast prices will rise from here.
The BOJ's closely watched median economic and price forecasts are compiled by taking out the highest and lowest projections made by the nine board members.
The central bank issues a semi-annual report with long-term projections on gross domestic product (GDP) and the core consumer price index (CPI) in April and October of each year. It reviews the projections in January and July.
($1=97.29 yen)
(Additional reporting by Sumio Ito and Yoshifumi Takemoto; Editing by Neil Fullick)
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