HIROSHIMA, Japan (Reuters) - The Bank of Japan will not hesitate to ease monetary policy further if risks to the country's economy heighten sharply, a deputy governor said on Wednesday, warning of the potential damage from Europe's simmering debt crisis and the strong yen.
The remarks came after two new members of the BOJ's policy board said on Tuesday that policymakers should be prepared to take bolder steps to end deflation, a sign the central bank stands ready to offer additional stimulus to the export-reliant economy should a yen spike and overseas slowdown hurt growth.
Deputy Governor Hirohide Yamaguchi stuck to the BOJ's view that Japan's economy is headed for a moderate recovery as robust domestic demand, driven by reconstruction spending from last year's earthquake, makes up for weakness in exports.
He also said the central bank is still scrutinising the effect of its monetary easing in February and April, which will broaden over time as it steadily purchases assets to meet the existing 70 trillion yen ($895 billion) target under its asset buying and loan programme.
"But of course if some kind of shock leads to the economy undershooting our forecast or heightens risks to the outlook sharply, we won't hesitate to ease monetary policy further," Yamaguchi told business leaders in Hiroshima, western Japan.
While few analysts expect the central bank to expand monetary stimulus in August, many say a spike in the yen or worsening developments in Europe could force it into action in coming months.
"Our main scenario is that the BOJ will ease further by expanding its asset purchase programme in October when it cuts economic projections in its twice-yearly outlook report," said Junko Nishioka, chief Japan economist at RBS Securities.
"But further easing could come sooner if Europe's crisis accelerates safe-haven fund flows to trigger a sudden spike in the yen and a decline in share prices, dampening sentiment."
The BOJ set a 1 percent inflation target and eased policy via an increase in asset purchases in February. It followed up with another easing in April to show its resolve to beat deflation, which has stifled the economy for most of the past two decades.
The central bank has stood pat since then and has stressed that it will only act again if risks to the economy heighten sharply enough to derail its forecast of a moderate recovery.
Many in the BOJ will probably want to save its ammunition again at the next policy meeting on August 8-9, although renewed yen rises, fanned by market jitters over the euro, are putting pressure on the bank to help exporters by taming the currency.
Yamaguchi said the central bank must be vigilant to risks clouding the outlook such as yen rises, Europe's debt crisis and uncertainty over the U.S. and Chinese economies.
"Exports have been somewhat lagging expectations due to the overseas slowdown," he said.
"Japan's economy is expected to resume a recovery. But the outlook is uncertain," Yamaguchi said, adding that exports need to pick up while the support from domestic demand lasts, for Japan to see a sustained recovery.
Exports fell in June from a year earlier, the first decline in four months, data showed on Wednesday, hurt by the slowdown in Europe, China and other markets.
Japan's economy is expected to outperform most other developed nations this year thanks to solid domestic demand, but analysts have slashed forecasts for factory output as the slowdown in external markets becomes more pronounced.
Yamaguchi, one of the BOJ's two deputy governors, is a key figure to watch for signals on the future direction of monetary policy. Markets count him among board members more eager to ease pre-emptively when needed to support the economy.
($1 = 78.2200 Japanese yen)
Additional reporting by Tetsushi Kajimoto; Editing by Michael Watson and Richard Borsuk