BOJ likely to warn of inflation whiplash from Iran war, ex-central bank executive says

* Before Iran war, BOJ likely planned to hike in March or April

* April quarterly report to warn of huge risks to inflation

* BOJ likely won't decide on rates in April until last minute

* BOJ expected to focus on long-term inflation outlook, 2027 wages

By Leika Kihara and Takahiko Wada

TOKYO, March 27 (Reuters) - The Bank of Japan is likely to warn of possible huge swings to underlying inflation in next month's quarterly report, as the Middle East conflict injects unprecedented challenges into rate-setting, its former executive Kazuo Momma said on Friday.

Before the February 28 U.S.-Israeli strikes on Iran, the central bank appeared poised to raise rates as soon as March or April, Momma noted, though that path has since been clouded by a spike in oil prices and shipping disruptions through the Strait of Hormuz.

Fading hopes for a swift end to the war now leave the BOJ grappling with profound uncertainty over how the oil shock will ripple through global and domestic growth, inflation dynamics and corporate wage-setting, he said.

These variables will likely prompt the central bank's upcoming quarterly report to warn of significant twin risks: the Middle East conflict hitting the economy through shrinking demand, and supply shocks fueling inflationary pressures, Momma said in an interview.

"With so much dependent on Middle East developments, the BOJ probably won't decide what to do with interest rates until the last minute," he said, referring to the prospect of a rate hike at the central bank's next policy-setting meeting on April 27-28.

"In times like now, there's no simple formula in setting policy unlike in the past, where the BOJ could do so looking at a few economic variables," said Momma, who retains close contact with incumbent policymakers. "It's truly extraordinary times for central banking."

Soaring oil prices from the conflict have complicated the BOJ's decision on how soon to resume rate increases, after hiking them to 0.75% in December. While rising fuel costs add to inflationary pressures from a weak yen, it hurts an economy heavily dependent on raw material imports.

The yield on five-year Japanese government bonds climbed to a new record high on Friday, as the escalating war fuelled inflation concerns and strengthened expectations of faster rate hikes by major central banks including the BOJ.

Analysts are focusing on the BOJ's quarterly outlook report due at next month's policy meeting for clues on how the Middle East conflict could affect its rate-hike path. Some still see a chance of a hike to 1.0% in April.

"What the BOJ would be focusing on is not near-term spikes in gasoline and oil prices, but how underlying inflation could be behaving one, two years ahead," said Momma, who is currently an executive economist at private think tank Mizuho Research & Technologies.

The outlook for underlying inflation would be swayed by various factors including the expected hit to global and Asian economies from oil supply disruptions, he said.

Another key would be how companies set wages in next year's annual negotiations, which is hard to predict now, Momma added.

With underlying inflation already close to the BOJ's 2% target, the additional price pressure from the Iran war could lead to an inflation overshoot, he said.

"But it's hard to say whether such inflationary risks are bigger than the risk of Japan sliding into recession," Momma said. "As a result, the BOJ would have to keep agonizing over what to do at each meeting."

The BOJ has said it will keep raising interest rates if Japan makes progress in underlying inflation, or prices driven by domestic demand and wages, stably hitting 2%.

As part of efforts to enhance communication on underlying inflation, the BOJ began releasing a new index stripping away special factors that showed inflation hitting 2.2% in February.

(Reporting by Leika Kihara and Takahiko Wada Editing by Shri Navaratnam)