BOJ to cut price forecasts, keep bright view of economy: sources

By Leika Kihara

TOKYO (Reuters) - The Bank of Japan is expected to cut its inflation forecasts at next week's rate review, sources say, a sign slumping oil prices and a darkening global economic outlook are heightening challenges for hitting its ambitious 2 percent target.

But the BoJ is likely to maintain its upbeat assessment that Japan's economy will keep expanding moderately as global growth is expected to emerge from a soft patch later this year, the sources familiar with the central bank's thinking, told Reuters.

"Oil prices have fallen significantly since the BOJ's previous projections in October and that will affect its upcoming forecasts," one of the sources said.

"But the underlying trend inflation remains solid," the source added, a view echoed by three more sources.

The central bank is widely expected to keep monetary settings unchanged at its two-day rate review ending on Jan. 23, maintaining a pledge to guide short-term interest rates at minus 0.1 percent and long-term bond yields around zero percent.

It will also issue a quarterly report analyzing Japan's economy that will include fresh growth and inflation forecasts through the fiscal year ending in March 2021.

Under the current forecasts made in October, the BOJ expects core consumer inflation to hit 1.4 percent in the fiscal year beginning in April and 1.5 percent the following year.

The BoJ's nine-member board is expected to slightly trim these forecasts to reflect recent declines in oil prices and the potential fallout from slowing global growth, the sources said.

The inflation forecast for fiscal 2019 may be cut to around 1 percent, the sources said, still above a 0.7 percent projection made by analysts polled by Reuters.

The BoJ is likely to roughly maintain their economic growth projections, as lower energy costs and government spending to mitigate the impact of a scheduled sales tax hike in October offset some of the pain from external headwinds, they said.

"Overseas risks are heightening. But they are not huge enough to undermine the BOJ's forecast of a moderate economic expansion," one of the sources said.

As part of efforts to prevent financial institutions from sitting on their huge pile of cash, the BoJ will also extend the March deadline for a lending scheme aimed at encouraging financial institutions to boost lending, the sources said.

Stubbornly low inflation has forced the BoJ to maintain a radical stimulus program despite the rising costs, such as the hit to financial institutions' profits from years of low rates.

Many BOJ policymakers are wary of ramping up stimulus, though external shocks could force the central bank to pull the trigger if the economy is at risk of sliding into recession, analysts say.

(Additional reporting by Sumio Ito and Ritsuko Shimizu; Editing by Simon Cameron-Moore)