By Leika Kihara

By Leika Kihara

TOKUSHIMA, Japan (Reuters) - Dissenting Bank of Japan board member Takehiro Sato said the central bank should be open to the idea of raising its bond yield targets before inflation hits its 2 percent goal, if improvements in the economy drive up long-term interest rates.

Sato also said the BOJ should not persist in maintaining the current pace of government bond purchases and consider reducing its massive holdings of treasury discount bills, since it now targets interest rates and not the pace of money printing.

"In my view, the yield curve that would be most appropriate for achieving favorable conditions in economic activity and prices should be a little steeper," Sato told business leaders in Tokushima, western Japan, on Wednesday.


He said consumer inflation may reach 1 percent by the end of this year as improvements in the economy lift household spending, which could make it "quite difficult" for the BOJ to maintain a pledge to cap 10-year bond yields around zero percent.

"If the board comes to a conclusion that economic and price developments are improving, the BOJ should consider fine-tuning its 10-year yield target," he told reporters after the meeting.

"I don't think it would go against the BOJ's mandate to raise the yield targets before inflation hits 2 percent," if economic improvements are driving up long-term rates, he said.

Under a new policy framework adopted in September, the BOJ now guides short-term interest rates at minus 0.1 percent and the 10-year government bond yield around zero percent.

The BOJ's attempt to control the yield curve has faced challenges as rises in global long-term interest rates, driven by expectations of steady rate hikes by the U.S. Federal Reserve, have put upward pressure on Japanese long-term rates.

Sato, whose five-year term ends in July, has consistently voted against the policy, arguing that pegging yields at such low levels could hurt Japan's banking system by hitting financial institutions' already narrowing margins.

He has also predicted some changes the BOJ made to its policies, including a decision to drop a two-year timeframe for meeting its price target to allow itself more time to achieve 2 percent inflation.

Sato said the BOJ should allow for a natural steepening of the yield curve, which could mean slowing its bond purchases, to prevent firms from holding off capital spending on expectations that current ultra-low borrowing costs will persist.

But he said there was no consensus in the board yet on how frequently and by how much the BOJ could raise its yield targets in the future.

Japan's January core consumer prices likely stopped falling for the first time in nearly a year, a Reuters poll showed, due to a pickup in energy prices and the global economic recovery.

Still, inflation remains distant from the BOJ's 2 percent target on weak consumption and wage growth, keeping the central bank under pressure to maintain its ultra-easy monetary policy.

The BOJ abandoned its policy targeting the pace of money printing and switched to one targeting interest rates in September, after three years of aggressive asset purchases failed to accelerate inflation to 2 percent.

But the nine-member board is split on how much emphasis the BOJ should place on the pace of its huge bond buying.

(Editing by Chris Gallagher and Simon Cameron-Moore)

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