The Bank of Japan kept monetary policy steady on Tuesday, standing its ground for now in the face of calls from the country's likely next prime minister to pursue unlimited easing to revive an economy widely seen in recession.
The leader of the main opposition, Shinzo Abe, has put the central bank at the centre of economic debate ahead of a Dec. 16 national election that surveys show his party would win, signalling his government would put the bank under much greater pressure to ease policy.
Abe has even suggested revising the Bank of Japan law, a step critics say is aimed at clipping the central bank's independence and forcing it to print money to finance public debt that is already double the size of Japan's economy.
At the end of a two-day meeting, the central bank left monetary policy unchanged, holding fire so it can size up the policies of a new government to be formed after the December vote for the powerful Lower House.
It also wants more time to assess the impact of policy easing in September and October, which raised the size of its asset buying and lending programme to 91 trillion yen ($1.1 trillion) -- roughly equal to Japan's annual state spending.
Markets barely reacted to the announcement as many had priced in the BOJ decision. But some analysts see a good chance the central bank will boost stimulus at its next rate review on Dec. 19-20, just days after the election.
The pressure on the BOJ is so strong that I don't think they can avoid easing next month after the results of the election, said Yasuo Yamamoto, senior economist at Mizuho Research Institute in Tokyo.
Increasing asset purchases is the most obvious option. Markets will now look to see how BOJ Governor Masaaki Shirakawa responds to the increased political heat and concerns over the central bank's independence when he holds a media briefing later in the day.
Japan's economy shrank 0.9 percent in the September quarter and given headwinds to growth in the current quarter, is widely expected to have slipped into a recession.
The BOJ maintained its assessment that the economy is weakening somewhat but warned that the persistent overseas slowdown was weighing on exports, output and business spending.
It also offered a slightly bleaker view on the outlook, saying the economy will remain weak for the time being before resuming a moderate recovery. In October, it had said economic growth will remain flat for the time being.
Abe, the leader of the Liberal Democratic Party (LDP), has called on the BOJ for bolder action, including unlimited easing, pushing rates to zero or below zero and directly underwriting bonds issued to fund public works spending. His comments have driven the yen to a near seven-month low against the dollar.
The BOJ is unlikely to give in to some of the extreme demands, such as underwriting debt, but is weighing options beyond its asset-buying programme, having cut policy rates effectively to zero, sources say.
The BOJ set a 1 percent inflation target in February and has eased policy four times so far this year. Abe has talked of setting an inflation target of 2 percent or 3 percent.
Despite the political pressure, the BOJ is caught in a dilemma. Bank notes in circulation are rising and the balance of deposits that commercial banks park with the BOJ is at a record high of 44 trillion yen as a result of its ultra-loose policy.
But bank lending rose a meagre 0.9 percent in the year to October, a sign the extra cash has not prompted companies and households to borrow more for new spending.
Under the current law, the BOJ is free to set monetary policy. But the government nominates the governor, deputy governors and board members, subject to parliament approval, giving it power to sway the direction of policy. Shirakawa's five-year term ends in April and both his deputies retire in March, giving the new government a chance to select who fills the top posts.
Government pressure has frequently driven the central bank into easing policy, particularly when a rise in the yen raised calls for measures to ease the impact of the stronger currency on the export-reliant economy.
While Abe's remarks have helped lift Tokyo share prices on expectations of bolder monetary stimulus, some analysts say his demands are unrealistic and they doubt whether he will stick to them once in power.
Many economists also warn that threatening central bank independence or forcing it to underwrite public debt could trigger an unwelcome spike in bond yields by raising doubts in markets about Japan's ability to keep its fiscal house in order.
Prime Minister Yoshihiko Noda was quoted by Japanese media as saying that he was opposed to forcing the BOJ to underwrite public debt or revising the central bank law, as doing so would go against Japan's fiscal reform efforts.