TOKYO (Reuters) - The Bank of Japan should maintain monetary easing until inflation is above its 2 percent target but should be mindful of financial distortions caused by its policies, the Organisation for Economic Cooperation and Development (OECD) said on Monday.
The BOJ's new policy framework gives it more flexibility, but it remains to be seen if will be successful and it could be difficult to target 10-year government bond yields, the OECD said in its semiannual Economic Outlook Report.
On the whole, the OECD welcomed the BOJ's decision in September to switch its policy target to interest rates from the pace of money printing, after years of massive asset purchases failed to jolt the economy out of stagnation.
But the OECD report highlighted concerns about the financial sector and the growing limitations on monetary policy.
"The Bank of Japan should maintain monetary easing, as intended, until inflation is stable above the 2 percent target, while taking account of costs and risks in terms of possible financial distortions," the OECD said in the report.
The BOJ revamped its quantitative easing to make policy more suited to a long battle to achieve inflation.
It now buys government bonds to keep the 10-year yield around zero and applies a negative 0.1 percent interest rate on a small portion of commercial banks' reserves.
The negative interest rate policy, which went into effect in February, has raised concerns about profitability for commercial banks and insurance companies, the Paris-based think tank said.
Additional scope for monetary policy is exhausted without strong fiscal spending and structural reforms in Japan and other advanced economies, the OECD said.
The report also said targeting the 10-year yield could be "complicated in practice."
Japan's economy will continue to grow in the next few years partly due to government stimulus spending, but China's economy remains a risk given it is Japan's largest export market, the OECD said.
The BOJ has repeatedly pushed back its timeframe for hitting its ambitious 2 percent inflation target, most recently to "around fiscal 2018", as weak consumption and falling import costs from a strong yen weigh on price growth.
Japan's core consumer prices marked their eighth straight month of annual declines in October, illustrating the sheer scale of the central bank's struggle to beat deflation and stagnant growth with diminishing policy options.
(Reporting by Stanley White; Editing by Kim Coghill)