By Leika Kihara
TOKYO (Reuters) -The Bank of Japan is warming to the idea of tweaking its controversial bond yield control policy later this year, but will likely keep settings unchanged at next week's meeting as it awaits more evidence of sustained wage growth, sources say.
Kazuo Ueda chairs his first policy meeting since becoming BOJ governor on April 27-28 and his appointment has heightened expectations the bank will begin unwinding its ultra-loose settings - the only question is when.
With global recession fears clouding the outlook, there is no consensus within the BOJ on how soon it can end yield curve control (YCC) - a policy that sets a short-term interest rate target of -0.1% and a 0.5% cap on the 10-year bond yield.
However, five sources familiar with the BOJ's thinking say the preferred approach, for now, is to stay the course, which means the bank will make no major immediate changes to YCC and its dovish policy guidance.
"Given looming overseas economic risks, it's appropriate to maintain ultra-loose monetary policy now," said one of the sources, a view echoed by two more sources.
But the nine-member board may engage in a more lively debate on the fate of YCC at its June 15-16 and July 27-28 meetings.
Doves in the BOJ see the need to spend plenty of time to ensure Japan's economy can weather external headwinds, and allow firms to keep hiking wages next year - even if that meant missing the opportunity to phase out stimulus in the current recovery cycle, some of the sources say.
The BOJ is mindful of the dangers of taking any premature steps that could be interpreted as a withdrawal of monetary support, with previous rate hikes in 2000 and 2006 having drawn strong political criticism as causing recession.
"The BOJ must avoid dampening public sentiment" by sending a message that could be interpreted as an early approach of an exit, one of the sources said, a view echoed by another source.
Others in the BOJ see scope to debate a tweak possibly in the coming months, emboldened by big pay hikes offered by major firms in annual spring wage talks, the sources say.
An intensifying labour shortage will likely keep companies under pressure to hike wages, even if the economy slows, according to those who see room for a near-term policy tweak.
"Japan's wage dynamics appear to be changing. It's possible for 2% inflation to be sustainably met," one source said.
In a sign the BOJ was growing confident about the outlook for wages, the bank said in a quarterly report on Thursday that pay hikes were broadening in many parts of the country, even among smaller firms.
Among key factors that could shape the debate is a final tally of this year's wage talk outcomes, due out in early July, that will show whether small firms hiked pay like their bigger counterparts did, they say.
Market developments will also be crucial in determining the timing of a policy tweak, they say.
As recent problems in the global banking sector make safe-haven Japanese government bonds (JGB) more attractive, the BOJ is under no immediate pressure to tweak YCC with the 10-year yield now hovering around 0.465%, off its 0.5% cap.
But the central bank may consider modifying its 10-year yield target or the allowance band set around it if renewed upward pressure on JGB yields makes the cost of defending the cap hard to ignore, the sources said.
With inflation exceeding 2%, markets have been rife with speculation Ueda will phase out or end his predecessor's massive stimulus that combines YCC with a big asset-buying programme.
Ueda has repeatedly said the BOJ will maintain ultra-loose monetary policy, including YCC, as sustained achievement of 2% inflation has yet to come into sight.