The Bank of Japan is expected to maintain ultra-low interest rates on Thursday and signal a cautious approach to rolling back its massive monetary stimulus, as political uncertainty and jittery markets cloud the outlook.
The ruling coalition's loss of a majority in a weekend election has heightened concerns about policy paralysis, raising the hurdle for additional rate hikes, analysts say.
The BOJ is likely in no rush to push up borrowing costs with inflation showing few signs of spiking and Japan's economic recovery fragile.
But sounding too dovish on the policy outlook could give speculators an excuse to sell the yen and fuel unwelcome falls in the currency.
The conflicting demands on policy could keep the BOJ from issuing clear signals on the timing and pace of further rate hikes, particularly ahead of the U.S. presidential election on Nov. 5.
"The domestic political turmoil is negative for economic activity and could be headwinds for the BOJ's rate-hike plans," said Naomi Muguruma, chief bond strategist at Mitsubishi UFJ Morgan Stanley Securities.
"But the BOJ may not afford to wait too long if yen falls accelerate and re-ignite upside inflationary risks," she said.
At the two-day meeting ending on Thursday, the BOJ is widely expected to keep short-term interest rates steady at 0.25%.
In a quarterly report to be released after the meeting, the board is seen making no major changes to its projection that inflation will move around 2% through early 2027.
Markets will instead focus on the BOJ's view on risks as Governor Kazuo Ueda has highlighted unstable markets and U.S. recession fears as key reasons to go slow in its rate-hike path.
After meeting his counterparts from major economies in Washington, Ueda offered a cautiously upbeat view on the outlook for the global economy. He is expected to hold a news conference at 3:30 p.m. (0630 GMT) on Thursday to explain the BOJ's policy decision.
"Ueda may still be cautious about the U.S. economy. But he will probably strive to convey that the BOJ's rate-hike path is intact to avoid weakening the yen further," said veteran BOJ watcher Mari Iwashita.
The BOJ may also drop hints by modifying the report's portion on future policy guidance. In the most recent report issued in July, the BOJ said it would continue to raise rates if economic and price conditions move in line with its forecast.
The board will likely debate whether additional language on risks or triggers for policy shifts should be included in the guidance, sources have told Reuters.
The BOJ ended negative rates in March and raised short-term rates to 0.25% in July on the view Japan was making progress towards sustainably achieving its 2% inflation target.
Ueda has repeatedly said the BOJ will keep raising rates if the economy moves in line with its forecast. But he has also said the bank was in no rush as inflation remained moderate.
A slim majority of economists polled by Reuters expect it to forgo a hike this year, though most expect one by March.
