By Leika Kihara
TOKYO, March 10 (Reuters) - The Bank of Japan is leaning towards easing monetary policy again next week, sources said, but there is disagreement among the seven policymakers on its board on how to justify such a move.
By easing, the central bank would avert government pressure and get breathing space after repeated calls by the finance minister for policies to achieve 1 percent inflation.
Many BOJ policymakers are leaving their options open as they struggle to justify acting now. Disagreement may result in a split vote when it meets on March 16-17.
"The economy is in good shape, so I wonder if everyone sees the need for action now," a source familiar with the BOJ's thinking told Reuters. The source was speaking on condition of anonymity because of the sensitivity of the matter.
Sources also said remarks by Deputy Governor Hirohide Yamaguchi were meant to signal that the bank was ready to act when he said last month that deflation was not easing as fast as he had expected.
Yamaguchi, a close aide to the BOJ governor and in charge of communicating the BOJ's views to the government, may eventually get the backing of many on the board.
NO AGREEMENT
While policymakers agree that they need to beat deflation, not all feel the BOJ should do something about it next week.
That is especially the case because the economy is performing in line with BOJ forecasts, with factory output increasing steadily on solid exports to Asia.
Opponents of easier policy also do not see how the BOJ's most likely next step, which is to spoon-feed banks with cash by expanding a funding operation adopted in December, will support growth when bank lending is falling on weak corporate demand.
In a sign that there is hardly a consensus, board member Tadao Noda said only a week after Yamaguchi spoke that he saw no need for a policy change now.
Miyako Suda, an academic-turned-board member, may also be cautious towards imminent easing as she has repeatedly warned of the drawbacks of keeping policy loose for too long.
"Although maintaining easy monetary policy is the top priority, it is important for the Japanese economy to undergo bold structural reform as much as it needs recovery," Suda told a forum on Wednesday, adding that monetary policy alone cannot fix deflation.
UNDER PRESSURE
Governor Masaaki Shirakawa himself may not be too enthusiastic either. He has said that with weak demand the root cause of price falls, there is no quick way out of deflation and little the BOJ can do beyond keeping rates near zero.
Markets have already factored in a chance of easing next week and with rising pressure from the government he may not have much choice.
The sources said that it would be crucial to persuade board members who have not decided that easing now would help lift household and corporate sentiment.
"If the BOJ were to ease policy further, price weakness and its effect on sentiment will be a key factor," the second source said.
Proponents of early action point to January's record annual fall in Japan's narrowest measure of consumer inflation as evidence that demand is weakening enough to deepen deflation.
Expanding the December fund-supply operation, either by boosting its size from 10 trillion yen ($111 billion) or by extending the duration of 0.1 percent loans to banks from three months, would not directly and immediately boost prices.
But by showing the BOJ's determination to fight deflation, it may lift household sentiment and the faster it acts, the better, some BOJ officials say. It will also further push down yen borrowing costs and help companies, they say.
One more justification to act next week rather than in April is the March expiry of an emergency lending facility launched in December 2008 to ease corporate funding in the financial crisis.
The expiry will leave a hole of around 6.4 trillion yen that needs to be filled with other market operations from April.
That would give the BOJ a good reason to decide next week to expand the December fund supply tool, aimed more at funnelling funds to markets.
Analysts say the final decision will depend greatly on how much pressure the government piles on the central bank.
"There are several ways to justify easing policy further next week. But in reality, the BOJ just wants the government off its back," said Kyohei Morita, chief Japan economist at Barclays Capital.
"Expanding the new operation frankly won't have that much of an effect in boosting the economy, regardless of how you try to explain it." (Additional reporting by Shigeo Kodama)