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TOKYO (Reuters) - The Bank of Japan is likely to keep monetary policy steady and give a more upbeat view of the economy on Tuesday, reinforcing market expectations that its future policy direction could be an increase - not a cut - in interest rates.
Japanese long-term interest rates have risen in tandem with global bond yields on expectations of steady U.S. interest rate hikes and the perceived inflation-stoking policies of incoming U.S. President Donald Trump.
This has tested the BOJ's resolve to cap the 10-year Japanese government bond (JGB) yield around its zero percent target.
That in turn has led to some market expectations the BOJ may raise its target for the 10-year JGB yield, which briefly hit 0.1 percent last week, as early as next year.
With no policy action expected at the two-day rate review that ends on Tuesday, financial markets are focusing on what BOJ Governor Haruhiko Kuroda will say at his post-meeting news conference about the recent rise in yields.
"Kuroda will probably warn that an abrupt jump in bond yields is unwelcome," said Yasuhide Yajima, chief economist at NLI Research Institute.
"He might also sound more upbeat about the economy but that could give markets the impression the BOJ is about to raise rates, which it won't do soon. It's tricky communication."
With the economy showing some signs of life, the BOJ is expected to keep unchanged its pledge to guide short-term rates at minus 0.1 percent and the 10-year JGB yield around zero percent.
Reflecting a pick-up in emerging Asian demand and factory output, the central bank is also seen upgrading its language to signal its confidence that the economy is headed for a steady, export-led recovery, sources have told Reuters.
At the previous meeting on Nov. 1, the BOJ said the economic trend was for moderate recovery, but slowing emerging market demand was weighing on exports and output.
While recent yen falls have heightened hopes for a rebound in exports, BOJ officials are by no means complacent on the outlook as any remarks by Trump warning against further dollar gains could reverse the positive market tide.
Kuroda is thus likely to reiterate that risks to the economic and price outlook are skewed to the downside.
Market expectations of additional monetary easing have receded after the BOJ revamped its policy framework in September to one better suited to a long-term battle against deflation.
With inflation stubbornly shunning its 2 percent target, however, the BOJ is in no rush to raise its 10-year JGB yield target, and sees any such move as a long-term option.
Still, the central bank is more open to discussing the idea and may contemplate raising the target as early as next year if long-term rates reflect clear improvements in the economy and keep rising, sources have told Reuters.
Reporting by Leika Kihara; Editing by Eric Meijer