By Leika Kihara
TOKYO (Reuters) - The Bank of Japan is set to keep monetary policy steady on Friday and may slightly revise up its assessment on overseas growth, signalling confidence that the economy is on course to meet its inflation target next year without additional stimulus.
Surprisingly strong capital expenditure and growing signs that Japan is weathering a recent domestic sales tax hike have underscored the central bank's view that the world's third-largest economy will continue to recover on solid domestic demand.
Overseas headwinds also appear to be receding, BOJ officials say, pointing to a rise in China's May exports and robust U.S. jobs data signalling the world's biggest economy has emerged from a soft patch blamed largely on severe winter weather.
The BOJ may thus offer a slightly more upbeat view on overseas economies than last month, when it said that while the global economy is starting to recover, "lacklustre performances" were seen in some areas.
Any such upgrade would signal the BOJ's hope that exports, the soft spot of an otherwise steady recovery, will soon emerge from the doldrums and cushion the pain from the sales tax hike that took effect in April.
"The weak yen hasn't boosted exports, so overseas economies need to grow more for Japanese shipments to pick up," said Hideo Kumano, chief economist at Dai-ichi Life Research Institute.
"The jobs data alleviated concerns about the U.S. economy and will help the BOJ make the case that overseas demand for Japanese goods will gradually recover," he said.
At a two-day rate review that ends on Friday, the BOJ is widely expected to maintain its monetary policy framework, under which it has pledged to increase base money by 60-70 trillion yen (£349-£406 billion) per year via aggressive asset purchases.
The central bank is set to keep intact its assessment that Japan's economy will continue recovering moderately as a trend, although it faces a speed bump from the sales tax hike.
Despite the optimism on overseas growth, the BOJ is also seen maintaining its assessment that exports are "more or less flat" since there has been no clear signs of a pick-up.
UPBEAT VIEW INTACT
Japan logged its fastest growth in two years in the first quarter thanks to surprisingly strong capital spending, in a fresh sign that the economy is in better shape to weather the hit from the sales tax hike.
While factory output and household spending slumped in April, consumer confidence rose for the first time in six months in May, underscoring the BOJ's projection that the tax hike impact would be temporary.
BOJ officials say it will take until around July to fully grasp the effect of the tax hike, and stress what is more important is how strongly growth will rebound in July-September from an expected contraction in the current quarter.
In his post-meeting news conference, Governor Haruhiko Kuroda is likely to reiterate his conviction that Japan is making steady progress toward meeting the BOJ's 2 percent inflation target sometime during the fiscal year beginning in April 2015.
But he is also set to reassure markets that the BOJ stands ready to offer further monetary stimulus if risks threaten the achievement of its price goal.
Markets are focusing on what Kuroda has to say about the series of measures the European Central Bank took last week to fend off the risk of Japan-like deflation and ease pressure on the strong euro.
Under an intense burst of stimulus launched in April last year, the BOJ pledged to double base money via aggressive asset purchases to end deflation and accelerate consumer inflation to 2 percent in roughly two years.
While inflation has exceeded 1 percent, private-sector analysts remain sceptical that price rises will accelerate much from here as the boost from a weak yen, which inflates import costs, begins to fade.
The BOJ argues that while consumer inflation may hover just above 1 percent for several months, it will then accelerate toward 2 percent late this year through early next year as the economic recovery gathers momentum.
Such bullish projections have led market players to scale back bets of further monetary easing this year.
(Editing by Kim Coghill)