By Leika Kihara
TOKYO (Reuters) - Brightening global growth prospects will allow Japan's central bank to keep monetary policy steady this week and invest time solving the puzzle of why inflation remains stubbornly low despite a tightening job market and robust economic recovery.
At the two-day rate review ending on Thursday, the Bank of Japan is set to offer a more upbeat assessment of the economy than it did last month as a pick-up in overseas demand bolsters exports and factory output, sources have told Reuters.
But central bank policymakers still have little to cheer about with consumer inflation barely above zero percent, as soft household spending discourages companies from raising prices.
And looming geopolitical risks, such as escalating tensions over North Korea, overshadow otherwise upbeat prospects for the global and Japanese economies.
"Japan's economy is recovering and expanding steadily as a trend," BOJ Governor Haruhiko Kuroda said last week, offering a brighter view than the central bank's current assessment that a moderate recovery trend was in place.
"But price momentum, while sustained, lacks steam," he added, signalling anew that the BOJ will maintain its massive monetary stimulus for the time being.
With the economy in good shape, the BOJ is widely expected to leave unchanged its commitment to guide short-term interest rates at minus 0.1 percent and the 10-year government bond yield around zero percent through aggressive asset purchases.
Analysts also expect the BOJ to maintain a loose pledge to keep increasing its government bond holdings by 80 trillion yen per year.
Japan's economy has shown signs of life, as exports rose the most in over two years in March and manufacturers' confidence climbed to the highest since the global financial crisis a decade ago.
But core consumer prices for February rose just 0.2 percent from a year earlier, keeping markets doubtful of the BOJ's forecast inflation will hit its 2 percent target by March 2019.
At a quarterly review of its long-term projections to be released on Thursday, the BOJ may slightly cut this fiscal year's inflation forecast but project price growth accelerating steadily toward its target in subsequent years, say sources familiar with its thinking.
"The BOJ's price forecasts are too optimistic, so there's a very high chance they will be revised down. This may happen at its quarterly forecast review in April," said Kazuo Momma, a former top BOJ economist.
In the current forecast made in January, the BOJ expects core consumer inflation to hit 1.5 percent in the year ending in March 2018, followed by 1.7 percent in fiscal 2018.
The BOJ may also offer an analysis on why inflation remains subdued despite a strengthening recovery, either in the quarterly report or at Kuroda's post-meeting briefing.
The International Monetary Fund called for labour market reforms to solve the conundrum.
"Despite a tightening labor market, wage demands are not stronger than in the past few years and thus are unlikely to kindle much-needed positive wage-price dynamics," the IMF said in its World Economic Outlook report last week.
"To attain a durable increase in inflation and growth, a comprehensive policy approach that enhances monetary accommodation with a supportive fiscal stance and reforms to labor market policies is needed," it said.
After three years of heavy money printing failed to drive up inflation, the BOJ revamped its policy framework last September to one better suited for a long-term war against deflation.
But critics say the central bank cannot sustain the current framework if its price target remains elusive for too long, as its heavy bond buying is already drying up market liquidity.