TOKYO, March 18 (Reuters) - The Bank of Japan may increase buying of government bonds to funnel more funds to markets, as Prime Minister Taro Aso mulls another stimulus package to battle a deepening recession.
But markets are divided on whether the central bank will opt for the move at its two-day rate review ending on Wednesday, which would push it closer to the policy of quantitative easing it has been trying to avoid.
"There is a 50-50 chance the BOJ will decide to increase outright buying of Japanese government bonds," said Naoki Iizuka, a senior economist at Mizuno Securities.
"I don't think the BOJ would opt for that action unless the bond market was going through severe turmoil, but there is the risk of causing a negative reaction in the market if the BOJ decides against it at today's meeting."
BOJ policymakers will debate whether to increase the central bank's outright buying of JGBs to 1.6 trillion yen ($16.22 billion) per month from 1.4 trillion yen. They are expected to keep interest rates unchanged at 0.1 percent.
The debate comes as some of the world's other central banks eye government bond buying as a way to stimulate their economies, with the traditional tool of cutting short-term rates rendered useless with rates already nearing the floor of zero.
The BOJ, which started buying JGBs more than four decades ago as part of its market operations, expanded its buying in the early 2000s, when Japan experimented with quantitative easing, in which the banking system is flooded with cash to encourage lending and get the economy moving.
In December, along with a rate cut, it increased the size of its outright JGB buying to 1.4 trillion yen per month.
The BOJ argues the move was not aimed directly at pushing down bond yields. But some economists say it would help keep sharp yield rises in check as the government considers a third stimulus package to ease the pain from a deepening recession.
On Tuesday the BOJ offered up to 1 trillion yen in subordinated loans to Japanese banks to bolster their depleted capital, seeking to prevent a drying up of lending to companies and households in need of cash.
Countries around the globe are striving to shore up banks' capital and limit the impact of toxic assets, to combat the global financial crisis that has engulfed their economies. ($1=98.62 Yen) (Reporting by Leika Kihara; Editing by Michael Watson)