By Leika Kihara
TOKYO (Reuters) - The Bank of Japan (BOJ) is set to maintain ultra-low interest rates, including a controversial bond yield cap, on Friday as it awaits a leadership transition that could eventually end outgoing chief Haruhiko Kuroda's massive monetary stimulus.
With rising inflation pushing up long-term interest rates, some investors bet the BOJ may tweak yield curve control (YCC), such as by raising the 10-year yield cap, as early as next week's policy meeting - the final one to be chaired by Kuroda.
But the BOJ is likely to hold off on making major changes to YCC given uncertainty over whether wages would rise enough to keep inflation sustainably around its 2% target, say four sources familiar with its thinking.
While markets have renewed their attack on the BOJ's yield cap, many central bank policymakers see no immediate need to take additional steps to iron out market distortions caused by its huge bond buying, they say.
"The BOJ already has sufficient tools to mend market distortions, which will take some more time to fix," one of the sources said, a view echoed by another source.
At the two-day meeting ending on Friday, the BOJ is set to maintain its short-term rate target at -0.1% and that for the 10-year bond yield around 0%.
Markets are rife with speculation the BOJ will phase out Kuroda's controversial stimulus policies when academic Kazuo Ueda, the government's nominee to become next governor, takes the helm in April.
In December, the BOJ stunned markets by widening the band around the 10-year yield target in a move that allowed the yield to rise to 0.5% from the previous 0.25%.
The bank's quarterly survey showed last week an index measuring the degree of bond market functioning hit a record low in February, a sign the December decision has done little to ease market distortions.
"It will take a certain amount of time to gauge the impact of the tweak we made to YCC on market function," BOJ board member Hajime Takata said last week, stressing that he saw no imminent need to make further tweaks to the policy.
Another board member, Junko Nakagawa, also said last week more time was needed to gauge whether the December widening of the band was enough to fix market distortions.
Kuroda, whose second, five-year term ends on April 8, will leave behind a mixed legacy with his massive stimulus praised for pulling the economy out of deflation - but straining bank profits and distorting market function with prolonged low rates.
While inflation has exceeded the BOJ's 2% target mostly due to rising raw material costs, Kuroda has stressed the need to maintain ultra-low rates until inflation is driven by strong domestic demand and higher wages.
In parliament confirmation hearings, Ueda stressed the need to support the economy with ultra-loose policy for now, saying a shift to tighter policy would only come when Japan's inflation trend accelerates significantly.