The Bank of Japan kept monetary policy steady on Friday but pledged to do its utmost to ensure the country's banking system remains stable if a Greek election this weekend ignites fresh global market turmoil.
Japanese banks have been relatively immune from the fallout of Europe's debt crisis due to their limited exposure to the region, although policymakers worry that a sell-off of global shares, if too big and sharp, would hit their balance sheets.
"The BOJ will do its utmost to ensure the stability of Japan's financial system, while giving particular attention to developments in global financial markets," the central bank said in a statement on its policy decision, signaling its readiness to pump huge amount of funds into the system should markets destabilize.
G-20 officials have told Reuters that central banks from major economies stand ready to take steps to stabilize financial markets by providing liquidity and preventing a credit squeeze if the outcome of Greek elections on Sunday causes tumultuous trading.
As widely expected, the BOJ held off on increasing the size of its main policy tool, a 40-trillion yen ($505 billion) asset buying program, saving its firepower in case prospects of a Greek exit from the euro triggers a spike in the safe-haven yen.
Bullish on Economy
The BOJ revised up its assessment on Japan's economy to say it is starting to pick up, convinced that robust private consumption and rebuilding from last year's earthquake will offset some of the pain from slowing global growth.
But it warned that global uncertainty remains high as Europe's debt crisis keeps markets on edge, signaling its readiness to offer further monetary stimulus if risks to Japan's recovery prospects heighten.
"Global markets remain nervous due to Europe's debt problems, so we need to be particularly mindful of market developments," the statement said.
National elections in Greece on Sunday could lay the path for Athens to leave the eurozone and if such prospects jolt markets, the first line of defense for the BOJ would be fund injections to calm Tokyo's money markets.
A fresh wave of global risk aversion could see investors flock to the yen and force it to a fresh record high above 75.31 per dollar, jeopardizing the economic recovery.
If that happens, the central bank would probably increase the size of its asset-buying program, said sources familiar with the bank's thinking.
Yuichi Kodama, economist at Meiji Yasuda Life Insurance, was surprised at the BOJ's optimistic view on the Japanese economy but said further easing cannot be ruled out.
"If the yen shoots up and stock prices fall, the BOJ may hold an emergency meeting to increase government bond purchases and buy bonds with longer dates until maturity," Kodama said.
"But any such action by the BOJ alone probably won't contain market turmoil," he said, adding that it may take concerted monetary easing steps by U.S. and European central banks to calm market jitters.
The BOJ eased policy in February and set a 1 percent inflation target to underline its resolve to reinflate an economy beset by deflation for much of two decades.
It relaxed policy again in April but has paused since then on the view that Japan's economy is headed for a moderate recovery.
Japan's economy is expected to outperform most of its G-7 peers this year with growth of around 2 percent, helped by reconstruction spending following last year's earthquake and tsunami.
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