By Tetsushi Kajimoto
OTSU, Japan (Reuters) - Bank of Japan board member Tadao Noda rebuffed on Thursday government overtures for looser monetary policy to support the fragile economy, saying he saw no need for further easing now.
He also ruled out increasing the amount of government bond purchases made by the BOJ and reiterated the central bank's view that an inflation target could undermine its attempts to achieve price stability.
Facing upper house elections expected in July, the fiscally constrained government is pressing the central bank for action to overturn deflation, which some policymakers worry could drag the economy back into recession.
"I can't observe any moves now that would show much change in the pace of price falls from that I forecast in January," Noda told reporters. "Thus, I understand that we don't need any change at all in monetary policy at the moment from what we set in January and February."
Instead, Noda urged the government to rein in Japan's bulging debt burden to avoid the risk of pushing up interest rates and so undermine the central bank's loose monetary policy.
Highlighting the fiscal problems in Greece, the banking industry veteran said there was no guarantee bond yields would remain low if Japan keeps accumulating debt.
"Markets are increasingly concerned about the risk of deteriorating fiscal balances causing rises in long-term rates and dampening the effect of monetary policy," Noda told business executives in western Japan.
"Sovereign risk is one such risk," he said. "It's thus important to secure fiscal discipline, clearly set a path for restoring fiscal policy and implement steps at the appropriate time."
The government, currently seeking parliamentary approval for record spending in fiscal 2010/11, is constrained by a public debt load that is almost twice the size of the economy, by far the biggest among developed nations.
Equally, the central bank has said there is little it can do to lift the economy since it has already cut its policy rate to just 0.1 percent.
"Noda made it clear that the ball is in the government's court," said Masamichi Adachi, senior economist at JPMorgan Securities Japan. "As the government's fiscal strategy draws market attention, he effectively urged the government to make sure it paves the way to restore fiscal health."
MARKETS SEE BOJ LOOSENING POLICY
The government is expected to produce a long-term plan on fiscal discipline in June. It ruled out an increase in sales tax for four years, raising doubts as to whether it can come up with a credible plan to rein in its debt load.
"There is no doubt that the current situation is quite severe," Prime Minister Yukio Hatoyama told a parliamentary committee on Thursday, adding though that it was not a "crisis."
Ahead of the upper house elections, Hatoyama is looking to offset a fall in his ratings due to funding scandals and doubts about his leadership.
In a sign the BOJ is in no mood for a fight, Noda told reporters he hoped Japan would escape deflation this year, echoing a wish expressed by Finance Minister Naoto Kan.
But Noda declined to elaborate when asked by reporters how his comment gelled with the BOJ forecast that deflation would last until early 2012.
Even though Noda played down the chances of fresh BOJ action, shorter-dated government notes gained on market speculation the BOJ will ease policy again at some time.
The five-year/20-year yield spread almost matched its widest in a decade as the five-year yield fell to a two-month low.
Indeed, after weeks of government pressure, the central bank called an emergency meeting in December to announce a three-month funding facility.
Analysts say if the BOJ was to take fresh action, it would expand December's funding steps. Some analysts think it would increase its long-term bond buying, a move that would please the government if bond yields spike on concern over Japan's fiscal deficit.
The BOJ already buys 21.6 trillion yen ($244.1 billion) in government bonds each year. Noda was cautious about raising the amount in case it is seen by markets as monetizing public debt.
He also warned that strengthening the BOJ's commitment to keep rates low, such as by setting an inflation target, may lead to imbalances building up in the economy by fuelling a view that cheap money will be available for a long time.
Debate about an inflation target has flared since Finance Minister Kan said inflation around 1 percent was desirable. However, the core consumer prices most closely followed by financial markets have been falling from a year earlier for 11 straight months.
A return to full-blown quantitative easing is also not an option since the policy the BOJ took four years ago -- setting a liquidity target and flooding markets with extra cash -- was not effective in beating deflation, Noda said.
"Noda is clearly shrugging off government pressure. He wants lawmakers to understand that returning to quantitative easing now would be harmful," said Seiji Adachi, senior Japan economist at Deutsche Securities.
Noda said demand in the economy was weak so he was focusing on pushing down money market rates with longer durations as they affect corporate and household borrowing costs.
Although the economy emerged from recession in the second quarter of 2009 following the global downturn, data shows the recovery is uneven.
Corporate capital spending in the fourth quarter of 2009 fell from a year earlier at a slower pace than in the previous quarter, pointing to a slight downward revision in GDP. Revised fourth-quarter GDP is due on March 11.
The BOJ has kept rates near zero and vowed to keep policy easy to beat deflation. Its next rate review will be on March 16-17.
(Additional reporting by Rie Ishiguro, writing by Leika Kihara; Editing by Hugh Lawson and Neil Fullick)