By Leika Kihara
TOKYO (Reuters) - The Bank of Japan is likely to revise up slightly its economic forecast for the fiscal year starting in April to reflect an expected boost from the government's latest spending package, sources familiar with its thinking said.
Any upward revision will allow the BOJ to justify keeping monetary policy steady at the Jan. 20-21 rate review, unless escalating tensions in the Middle East trigger a yen spike big enough to derail a fragile economic recovery, analysts say.
Under current projections made in October, the BOJ expects Japan's economy to expand 0.7% in fiscal 2020, accelerating to 1.0% growth the following year.
At the January review, the BOJ is seen revising up its growth projection for fiscal 2020 to near 1%, taking into account the boost from the government's $122 billion stimulus package, three sources said on condition of anonymity.
The conflict between Iran and the United States, however, could potentially change the picture as a spike in oil costs and fears of military escalation could cool global growth and Japanese business sentiment, a fourth source said.
The nine-member board will scrutinise developments until the last minute in finalising its quarterly growth and inflation forecasts at the January rate review, the sources said.
"There will certainly be some positive impact from the government's fiscal package," said one of the sources, a view echoed by two more sources.
"But Japan's economic growth was probably very weak in the final quarter of last year, which would be a damper to the outlook," the source said.
Any upward revision will likely be minor as the positive effect from the package will be moderated by weak exports and output, as well as the hit to consumption from a sales tax hike that was rolled out in October, the sources said.
INFLATION FORECASTS INTACT
Japan's economy ground to a near halt in July-September and is likely to have contracted in the final quarter of last year as the U.S.-China trade war knocked exports.
The government expects the fiscal package to push up gross domestic product by 1.4% through fiscal 2021. But analysts say the boost could be smaller and may not come quickly as a tight labour market delays public works projects.
While the situation in the Middle East has emerged as a new risk, the BOJ is likely to maintain its view that Japan's economy will continue to expand moderately, the sources said.
BOJ officials hope robust capital spending and some bright signs in the global economy, such as a temporary truce in the U.S.-China trade war, will underpin growth.
But some officials fret that soft global demand for cars and machinery - goods where Japanese firms are competitive - could keep any rebound in January-March growth weak, the sources said.
The BOJ board will also review its current forecasts for core consumer inflation to hit 1.1% in fiscal 2020 and to accelerate to 1.5% the following year.
While rising energy costs and the boost from the fiscal package could offer some lift to inflation, the BOJ is unlikely to make big changes to the current projection, the sources said.
Projections of tame inflation will reinforce market expectations that the BOJ will keep monetary policy ultra-loose to achieve its elusive 2% price goal, analysts say.
(Reporting by Leika Kihara; Additional reporting by Takahiko Wada; Editing by Hugh Lawson)