The Bank of Japan is likely to keep interest rates ultra-low on Friday but consider whether to start reducing its huge balance sheet in a slow but steady retreat from its massive monetary stimulus.
However, the normalisation of Japan's still-loose monetary policy is clouded by weak consumption and doubts over the BOJ's view that robust domestic demand will keep inflation on track to durably hit its 2% target.
Receding prospects of steady U.S. interest rate cuts may also keep the yen weak against the dollar, complicating the BOJ's policy deliberations.
Japan's battered currency has become a headache for policymakers by inflating import prices, which in turn boosts living costs and hurting consumption.
"Underlying inflation remains short of 2%. Domestic demand is sluggish, so there's little sign a positive wage-inflation cycle will strengthen ahead," said Junichi Makino, chief economist at SMBC Nikko Securities.
"But the BOJ may be compelled to tighten monetary policy as long as weak-yen risks remain," he said.
Markets are focusing on how Governor Kazuo Ueda, at his post-meeting briefing, reconciles recent weak signs in the economy with the bank's current projection that Japan will make steady progress towards achieving its price target.
At the two-day meeting ending on Friday, the BOJ is expected to keep its short-term policy rate target in a range of 0-0.1%.
The central bank may trim its bond purchases or drop clues on its future taper plan to soothe market jitters, caused in part by a lack of detail on how it will scale back its $5 trillion balance sheet, sources have told Reuters.
A Reuters poll showed nearly two-thirds of economists expect the BOJ to start tapering its monthly bond buying, now set at around 6 trillion yen ($38 billion), on Friday.
The BOJ's efforts to normalise monetary policy comes as other major central banks, having already tightening monetary policy aggressively to combat soaring inflation, look to cut rates.
The Federal Reserve held interest rates steady on Wednesday and signalled the chance of a single cut this year. The European Central Bank slashed interest rates last week for the first time since 2019.
The BOJ finally exited negative rates and bond yield control in March. It has also dropped signs that it will keep raising short-term rates to levels that neither cool nor overheat the economy - seen by analysts as being somewhere between 1-2%.
In a sign of the BOJ's resolve to keep hiking rates, Ueda stuck to his view that rising wages will underpin Japan's recovery even after the economy contracted in the first quarter.
The BOJ is also under pressure to embark on quantitative tightening (QT) and scale back its huge balance sheet to ensure the effect of future rate hikes smoothly feed into the economy.
($1 = 157.0300 yen)
