By Leika Kihara
TOKYO (Reuters) - Bank of Japan policymakers meeting next week will start debating how to justify maintaining their rosy inflation forecasts even as a slew of weak data will likely force them to cut their economic growth projections later this month.
The central bank is widely expected to keep monetary settings unchanged at its two-day policy meeting ending on Tuesday, which precedes a more crucial rate review on Oct. 31 that will produce fresh quarterly long-term economic forecasts.
Sources have told Reuters the BOJ will cut its economic growth projection for the current fiscal year ending in March 2015, but maintain its rosy price estimates that see inflation nearing its 2 percent target next year.
While the BOJ board members won't produce their growth and price forecasts until Oct. 31, they already have enough data to discuss how the economy is faring from the pain of the April tax hike, soft exports and rising costs of living for households as the weak yen lifts import costs.
"The BOJ will probably remain bullish about the outlook for inflation. The focus will be on how it will explain the underlying weakness in the economy and prices," said Masaaki Kanno, chief economist at JPMorgan Securities Japan.
"Inflation expectations aren't heightening, which puts the BOJ in a tight spot. But central bankers probably feel they still have time before admitting that meeting their price target next year could be difficult," he said.
Shocked by the slump in August factory output, the BOJ is likely to offer a bleaker view on industrial production next week, said sources familiar with its thinking.
Many central bank policymakers also acknowledge that the economy's rebound from a severe contraction in the second quarter has been delayed with the April tax hike and bad summer weather dealing a heavier expected blow to household spending.
The board is thus likely to roughly halve its growth forecast for the current fiscal year from the present 1.0 percent rise, sources say, which is far more optimistic than a 0.3 percent increase seen by analysts polled by Reuters.
But the BOJ is in no mood yet to sharply cut its consumer inflation forecast, worried that doing so will give markets the impression it is not confident of meeting the target next year and will heighten speculation of imminent monetary easing.
BOJ officials argue that with corporate revenues rising, companies will keep hiring more and raise wages. That will prompt households to spend more again, allowing companies to charge more for their goods and services. They cling to the view that after a temporary soft patch, the economy will resume a moderate recovery that will accelerate inflation to 2 percent next year.
BOJ Governor Haruhiko Kuroda has put on a brave face, saying on Wednesday that the bank's "tankan" survey showed companies' spending appetite remained strong and that a positive economic cycle was still in place.
But such optimism rests on shaky ground. So far, wages have not risen enough to make up for the pain households feel from the higher sales tax and the rising cost of living. Exports have also failed to pick up despite the boost from a weak yen.
At next week's meeting, pessimists in the board may thus propose offering a bleaker assessment on the economy, though this will be a close call as there is still near-consensus that any downturn in the economy will be temporary, sources said.
The BOJ has stood pat on monetary policy since deploying an intense burst of stimulus in April last year, when it pledged to achieve its 2 percent inflation in roughly two years via aggressive asset purchases.
In its latest long-term forecasts made in July, the bank expects core consumer inflation to hit 1.9 percent in the next fiscal year, higher than 1.2 percent forecast in a Reuters poll.
The BOJ produces a semi-annual outlook report on the economy and prices each April and October of the year, and reviews these forecasts in January and July. The report serves as the basis for monetary policy decisions.
(Editing by Kim Coghill)