By Leika Kihara and Kaori Kaneko
TOKYO (Reuters) - Bank of Japan Governor Masaaki Shirakawa defended the central bank's aggressive monetary expansion, saying it was aimed at reviving the economy not at weakening the yen, as the country came under fresh international criticism ahead of a closely watched G20 gathering.
His comments came after data showed Japan's economy unexpectedly contracted in the fourth quarter, failing to escape a mild recession and playing into the hands of a government pushing for more radical stimulus measures that could cause the currency to weaken further.
Shirakawa said he would make that point clear to his Group of 20 counterparts at the weekend meeting in Russia, where Japan may face heat from some countries unhappy with the yen's recent steep falls, such as export competitor South Korea.
"The BOJ is conducting monetary policy to achieve stability in Japan's economy. It will continue to do so," he told a news conference on Thursday, hours before heading for Moscow.
Expectations that Prime Minister Shinzo Abe will keep pushing the central bank for bolder measures to beat deflation have driven the yen down nearly 20 percent against the dollar since November.
That has offered some relief to the export-reliant economy, which contracted 0.1 percent in the fourth quarter but is showing some signs of a pick-up, thanks to improving global demand and the effect of policy stimulus.
The BOJ struck a more positive note on the economy earlier in the day while keeping its policy on hold, after having boosted its monetary stimulus and doubled its inflation target to 2 percent just a month ago.
The yen's fast-paced declines, however, have stirred an international debate over whether Japan was effectively using money printing to steer the yen lower.
South Korea's central bank warned on Thursday that Japan's expansionary monetary policy could affect that country's future growth as a weak yen could undercut Korean exporters' competitiveness.
Japan has said the Group of Seven rich nations accepted Tokyo's view when it declared in a statement on Tuesday that fiscal and monetary policies would not be directed at devaluing currencies.
Shirakawa and Finance Minister Taro Aso, who will also attend the G20 gathering, may have a tough time selling their pitch to suspicious counterparts, as many Japanese policymakers have until recently openly talked about the benefits of a weak yen on Japan's exports.
Former BOJ Deputy Governor Kazumasa Iwata, who is considered as one of the leading candidates to replace Shirakawa when he leaves his post in March, was quoted as saying that the yen is still overvalued from a trade perspective.
Shirakawa himself acknowledged that recent yen declines will gradually underpin exports, helping Japan's economy resume a moderate recovery around the middle of this year.
The dollar traded around 93.50 yen on Thursday after hitting a 33-month high of about 94.47 yen on Monday.
NO FOREIGN BOND BUYING?
The world's third-largest economy contracted 0.1 percent in October-December to mark the third consecutive quarter of declines, compared with economists' forecasts for a very modest expansion of 0.1 percent. But recent sentiment surveys and leading indicators, such as machinery orders, have pointed to a gradual recovery in coming months.
"There is a strong chance that the economy will grow in January-March. China's economy is picking up and the United States is also on solid footing," said Yuichi Kodama, chief economist at Meiji Yasuda Life Insurance in Tokyo.
"Yen weakness has proceeded under 'Abenomics'. Corporate sentiment has improved, which will lead to an increase in capital expenditure."
The BOJ maintained its key policy rate at a range of zero to 0.1 percent on Thursday and held off expanding its asset buying and lending program, while offering a rosier view of the economy than a month ago, saying it "appears to be bottoming out."
Still, markets have no doubt that Abe will keep pushing the central bank for more in order to reflate the economy, given its still fragile state.
However, a return to rising prices appears far off after nearly two decades of low-grade deflation.
Shirakawa warned that wages would need to rise sustainably for Japan to achieve the BOJ's 2 percent inflation target, which would be a challenge in a country where companies tend to keep wage growth slow to protect jobs.
In a rare move for a premier, Abe himself made a direct plea to corporate executives for their cooperation in raising salaries, which met a cool response.
Abe, who has the right to fill three top BOJ posts when Shirakawa and his two deputies leave on March 19, is widely expected to pick advocates of more aggressive monetary easing than the cautious outgoing chief.
Whoever succeeds Shirakawa, however, will face the challenge of trying to create inflation with a depleted policy arsenal.
The BOJ is already struggling to force-feed cash to markets awash with funds, and intensifying global heat over the weakening yen may rule out one of its few remaining options: buying foreign bonds.
"The BOJ is expected to step up its monetary stimulus efforts under a new governor, and an increase in long-dated government bond purchases would be an option," said Izuru Kato, chief economist at Totan Research in Tokyo.
"But I think it would be difficult for the BOJ to buy foreign bonds, considering relations with the G7 and G20."
(Additional reporting by Stanley White; Writing by Tomasz Janowski and Leika Kihara; Editing by Kim Coghill)