The Bank of Japan is widely expected to leave its policy rate unchanged to keep financial conditions accommodative but will debate whether to reduce its buying of government bonds at its two-day policy meeting from Thursday.
Financial markets expect the Japanese central bank to reduce bond buying, currently set at around 6 trillion yen ($38 billion) a month, after its first interest rate hike in 17 years in March failed to reverse the yen's weakening trend while sending long-term yields higher amid expectations of policy normalization.
Due to the yen's weakness, particularly against the U.S. dollar, the BOJ has its work cut out for it. While the central bank does not guide monetary policy to influence foreign exchange rates, it faces increasing pressure to address the yen's depreciation.
A weaker yen raises the costs of imported items, threatening to dampen consumer appetite further. The BOJ is expected to examine the impact of rising prices of everyday goods on private consumption.
After his earlier remarks were interpreted as tolerating yen weakness, BOJ chief Kazuo Ueda has said the central bank will consider a policy response, depending on the impact of yen declines on inflation.
The U.S. Federal Reserve on Wednesday kept its federal funds rate, its policy rate, at a range of 5.25 and 5.50 percent, signaling just one rate cut this year which is fewer than expected. The decision lifted the dollar against the yen with the BOJ expected to maintain its range for short-term rates of zero and 0.1 percent on Friday.
The wide interest rate gap between Japan and the United States has dented the appeal of the yen, which had a sharp drop after the BOJ's previous meeting in April prompting Japan to step into the currency market by spending 9.79 trillion yen to stop its slide.
Despite this year's annual wage negotiations between labor unions and management yielding the best outcome in three decades, many households have yet to feel the benefits, partly because pay growth has not kept pace with inflation.
Analysts say the BOJ will probably wait until around this fall to implement another rate hike. Since it ended its yield cap program, the benchmark yield on the 10-year Japanese government bond has risen above 1.0 percent.
As a sharp rise in borrowing costs would hurt companies and households, the central bank has vowed to keep buying government bonds. It already owns about half of the outstanding government debt due to its massive monetary easing program over the past decade.
Ueda has said the BOJ would reduce bond buying as it moves toward an exit from massive monetary stimulus going forward. But he told parliament in early June that it would be cautious "not to make a big mistake" when raising interest rates.
BOJ board members have expressed growing confidence about the possibility of attaining the central bank's target of 2 percent inflation stably and sustainably, accompanied by wage growth.
