*What: Bank of Japan monetary policy meeting
*When: Rate decision expected noon-2 p.m. Friday
*BOJ is seen considering cutting rates to 0.25 percent
*Economic outlook report due at 3 p.m. Friday
*BOJ is seen slashing its growth projections sharply
*It may unveil measures to help stabilise financial markets
By Hideyuki Sano
TOKYO, Oct 29 (Reuters) - The Bank of Japan is seen considering cutting its interest rate target for the first time in seven years as it grapples with a slump in Tokyo share prices and a surge in the yen.
The cental bank may consider other options such as buying shares from banks, a step the government wants it to consider, or paying interest on banks' reserve deposits, which is seen as effective in fine-tuning its market operations.
The bank is also widely expected to slash its economic growth forecasts for the current fiscal year ending next March 31 and for 2009/10, as Japan, once seen as a safe haven in the credit crisis, begins to feel the full force of the turmoil with share prices plummeting to a level not seen since 1982.
"Given the current situation in financial markets, a 0.25 percentage point cut is highly likely," said Susumu Kato, chief economist at Calyon.
The BOJ will consider cutting interest rates although it will monitor global markets before deciding whether to pull the trigger, a source with knowledge of the matter told Reuters on Wednesday.
The fall in the Nikkei share average, which shed a third of its value in less than a month, and the jump in the yen may be the last straw for the BOJ, which has downgraded its economic assessment repeatedly in the past few months.
BOJ officials have been sticking to the view that the economy will gradually return to a moderate growth path by 2010, but in recent weeks they have been putting more emphasis on great uncertainty over the economic outlook.
The central bank is expected to forecast growth of around 0.5 percent or less in both 2008/09 and 2009/10, compared with its projections in July of 1.2 percent and 1.5 percent, respectively.
A sharp fall in oil prices since July means its forecast of consumer inflation will also be lowered.
The BOJ has been reluctant join the global push to ease monetary policy so far, preferring to keep its powder dry for an emergency in the domestic economy, which was largely shielded from the initial waves of the crisis.
Newly appointed Deputy BOJ Governor Hirohide Yamaguchi, seen as a close aide of Governor Masaaki Shirakawa, said on Monday that Japan's interest rates are low in light of the nation's economic conditions.
Thus some analysts think the central bank may still prefer to keep rates on hold for now.
"I still think the chance of a rate cut is 50-50. They will consider a cut but they may not cut rates this time and come up with some measures to ease pressure on funding among companies," said Mari Iwashita, chief market economist at Daiwa Securities SMBC.
One such possible option is outright buying of commercial paper (CP), which would make it easier and cheaper for companies to issue CP, analysts said. Japanese corporate finance has been unaffected by the global credit crisis as Japanese banks have remained relatively well capitalised.
But some sectors, such as real estate, have been finding it hard to raise funds, leading to a rise in failures of mid-sized real estate developers.
The central bank is also likely to consider buying shares from banks, after the government requested such a step to halt a free-fall in Japanese share prices.
Deputy Governor Yamaguchi said this week the BOJ is looking at ways to reduce risks for banks due to their stock holdings.
Another possibility is paying interest on reserve deposits -- a step the U.S. Federal Reserve started earlier this month so it can continue to provide liquidity on a large scale without letting interest rates fall too much.
Because of huge fund supply, interest rates have tended to fall in the afternoon when most banks finish fund-raising, making it hard for the Fed to guide rates near its policy target.
Receiving interest on reserves gives banks an incentive to send extra cash to the central bank, rather than lend in money markets at a lower rate when fund demand weakens in the afternoon.
But some analysts think the BOJ is not hard pressed to take such steps as Japanese money markets are more stable than those in the United States. (Editing by Michael Watson)