The Bank of Japan is expected to hold off on easing monetary policy next week, with the yen's retreat from its record high and resilient stock market allowing it to save its limited options to support the fragile economy for later.
The central bank has not let its guard down and may choose to ease policy for a second straight meeting if Friday's U.S. payrolls data pushes the dollar well below its record low hit last month and triggers a stock market sell-off.
Otherwise, the BOJ will hold fire until October and wait for more clues on whether risks have heightened enough to alter its forecast that the world's third largest economy will resume moderate growth in autumn after a slump triggered by March 11 earthquake, tsunami and nuclear crisis.
Here are possible outcomes from the meeting:
STAND PAT ON POLICY
POSSIBILITY: HIGHLY LIKELY
The central bank is sticking to its recovery scenario but feels that the global slowdown and stubbornly strong yen have heightened the risk of Japan's economy undershooting its forecast, with the fallout already showing in domestic factory output.
Still, it feels it has acted against such risks with last month's easing and prefers to stand pat if markets stay calm.
The BOJ sees plenty of reasons to save its depleted policy arsenal for now. The Federal Reserve has signalled expanding monetary stimulus in September, which may drive up the yen again and hurt exports already slowing from soft global demand.
Political pressure for central bank action may also heighten next month, when debate on how to foot the bill for post-quake reconstruction starts in earnest under Japan's new premier Yoshihiko Noda.
All this makes it more likely the BOJ will consider easing policy in October, rather than now.
MARKET REACTION: Markets will not react much unless Governor Masaaki Shirakawa signals a strong chance of monetary easing next month in his post-meeting news conference.
EASE POLICY BY BOOSTING ASSET PURCHASES
POSSIBILITY: LESS LIKELY
Some central bankers have doubts whether Japan's economy will resume a recovery in autumn, worried that the global slowdown may be more serious than initially thought.
The BOJ is thus determined to quickly counter any adverse market moves that threaten the fragile economy. That means it may act if Friday's U.S. payrolls data pushes the yen well above a record 75.95 to the U.S. dollar hit last month.
But monetary easing becomes a serious option only if the yen rises very sharply and stays at record-high levels long enough to jolt Tokyo stock prices.
If the central bank were to ease policy, it will boost its asset buying scheme -- which was topped up just last month -- by another ¥5-trillion ($65-billion U.S.) with most of the increase to be in government bonds and exchange-traded funds.
MARKET REACTION: Bond yields and the yen may fall while stock prices may rise, although the impact will be short-lived.
REVERT TO FULL-BLOWN QUANTITATIVE EASING
POSSIBILITY: HIGHLY UNLIKELY
The central bank regards the asset buying scheme, targeting government bonds and a range of private debt, as its key monetary policy tool. But it can probably only top it up once or twice, given there are limits to how much more of risk assets it can buy without hurting its balance sheet.
It is thus pondering alternatives. While the BOJ will not revert to old-style quantitative easing of targeting reserves parked at the central bank, it may consider buying government bonds more aggressively either by accepting debt with longer durations or significantly boosting the size of purchases.
But this is not an immediate possibility and more an option that may emerge later this year in case Japan experiences a severe economic downturn.
MARKET REACTION: The surprise move will knock down bond yields and the yen.