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TOKYO (Reuters) - The Bank of Japan is set to upgrade its economic assessment as early as next week to signal its growing conviction the recovery is gathering momentum, people familiar with its thinking told Reuters, reinforcing expectations its next move would be to tighten monetary policy.
It would follow an upward revision in April, when the central bank signaled that growth was shifting into higher gear after emerging from the doldrums.
But inflation remains stubbornly weak and may force the BOJ to again cut its price forecast at a quarterly review of its projections in July, the people said.
The disconnect between growth and inflation suggests the BOJ will be in no rush to withdraw the massive monetary support put in place to meet its 2 percent inflation target, analysts say.
"Almost all components of the economy are performing well. There's no doubt the economy is in pretty good shape," one of the people said. "Inflation, on the other hand, has been underperforming," the person added, a view echoed by two other sources.
At the previous policy meeting in April, the BOJ offered the most optimistic assessment in nine years to say the economy has been "turning toward a moderate expansion."
The central bank will brighten the language to describe the economy as "expanding moderately," either at a rate review on June 15-16 or the following meeting in July, the people said.
The change underscores a growing view within the BOJ that the benefits of the export-driven recovery are broadening and pushing up domestic demand, making it resilient to any future slowdown in overseas shipments, they said.
Japan's economy grew in the first quarter at its fastest pace in a year on robust exports and a helpful boost from private consumption. Analysts expect the economy to continue growing above its potential as long as overseas demand holds up.
Still, core consumer prices rose just 0.3 percent in April from a year earlier, as companies remain wary of raising prices for fear of scaring away price-sensitive households.
Wage growth remains tame, dashing central bankers' hopes that a tightening job market will lead to higher wages and give households more income to spend.
The yen's JPY= recent rebound and stalling oil price rises LCOc1 also mean the boost to inflation from higher import costs could be smaller than initially expected, analysts say.
The BOJ may thus cut its inflation forecast for the current fiscal year at its July 19-20 rate review, when it conducts a quarterly review of its projections, the sources said.
The central bank now projects core consumer inflation to hit 1.4 percent in the year ending March 2018 and 1.7 percent in fiscal 2018.
That is far more optimistic than forecasts made by analysts in a Reuters poll in May that inflation will hit 0.7 percent in the current fiscal year and 0.9 percent the following year.
"Consumption is holding up, but is not strong enough to convince companies they can now raise prices," said Yoshiki Shinke, chief economist at Dai-ichi Life Research Institute.
"I can't see how the BOJ can avoid cutting its inflation forecast in July. The question is how big the cut would be."
After four years of heavy money printing failed to drive up inflation, the BOJ revamped its policy framework last year to one better suited for a long-term battle against deflation.
Despite a strengthening economy, the BOJ is seen lagging well behind its U.S. and European counterparts in normalizing monetary policy given stubbornly low inflation.
Of the eight policy-setting meetings held each year, the BOJ reviews its long-term growth and price forecasts at four, including one in July. It also issues a verbal assessment of the state of the economy and inflation at all eight meetings.
For a graphic on BOJ's battle with deflation, click here
For a graphic on BOJ's ballooning balance sheet, click here
Additional reporting by Sumio Ito; Editing by Ian Geoghegan