TOKYO (Reuters) - The Bank of Japan should maintain quantitative easing until inflation exceeds its price target but it must be alert to the risks posed to asset prices and the financial sector, the Organisation for Economic Co-operation and Development said.
The OECD raised Japan's 2017 economic growth forecast to 1.2 percent, from 1.0 percent in November, because of an expected pickup in consumer spending, exports and capital expenditure.
However, the Paris-based think tank maintained its forecast growth will slow to 0.8 percent in 2018, highlighting the difficulty Japan faces achieving sustainable growth.
To improve this situation, Japan should raise the minimum wage further and improve productivity at small- and medium-sized enterprises, the OECD said in its latest economic assessment.
"Achieving the 2 percent inflation target should remain a top priority, while monitoring the potential costs and side effects," the OECD said.
The BOJ currently applies a negative 0.1 percent interest rate on a small portion of commercial banks' excess reserves.
It also buys government debt to keep the 10-year bond yield near zero and buys exchange-traded funds to lower risk premiums.
The BOJ's holdings of government debt now total around 40 percent of all outstanding debt, which could hurt liquidity and lead to market instability when the central bank exits the policy, the OECD said.
The central bank's policy mix could push up asset prices by encouraging excessive risk-taking, the OECD said. Negative interest rates could hurt bank earnings and make asset management more difficult for pension funds and life insurers, the report said.
Exiting quantitative easing is still far away given that inflation is around zero, the OECD acknowledged.
The OECD called on the government to promote consumption by raising the minimum wage to half the level of median wages. Currently Japan's minimum wage is around 40 percent of the median, one of the lowest among OECD member countries.
Japan's public debt burden, which is the worst among advanced nations at more than twice the size of its economy, needs to be brought down with spending cuts and gradual increases in the sales tax, the OECD said.
Japan's government has twice delayed a plan to raise the nationwide sales tax to 10 percent from 8 percent.
The tax hikes are needed to pay for rising welfare costs, but the government has backed away after a hike to 8 percent from 5 percent in 2014 hurt consumer spending.
"I am on record for supporting the original date for raising the sales tax to 10 percent from 8 percent," OECD Secretary-General Angel Gurria told reporters.
"Japan needs the money. I was hoping for something gradual, steady and predictable. Instead we stopped at 8 percent."
Gurria also said he felt the sales tax could rise to 15 percent or more.
Reporting by Stanley White; Editing by Eric Meijer and Richard Borsuk