Bank of Japan set to hike rates to 31-year high, drop hawkish signals

By Leika Kihara

TOKYO, June 12 (Reuters) - The Bank of Japan is set to raise interest rates to a 31-year high next week and signal its readiness to keep pushing up borrowing costs, undeterred by the absence of its governor as it focuses on countering inflation risks from the Middle East war.

The decision would align the BOJ with other central banks shifting towards tighter policy including the European Central Bank, which delivered a much anticipated hike on Thursday.

Governor Kazuo Ueda, now in hospital for a two-week treatment for an infected liver cyst, will miss the two-day meeting concluding on June 16.

The remaining eight board members, many of whom have warned of mounting price pressures, are likely to raise the policy rate to 1% from 0.75% - taking it to levels unseen since 1995.

"Ueda's absence won't affect the BOJ's institutional decision to focus on mounting inflation risks rather than risks to growth from the Middle East conflict," said Saisuke Sakai, senior economist at Mizuho Research Institute.

The hike would be the first since December and mark a pivot away from the BOJ's cautious approach dismantling the remnants of the radical stimulus of Ueda's predecessor, towards a focus on the conventional central bank role of fighting inflation.

UCHIDA COMMENTS IN FOCUS

With a hike next week near fully priced in, markets are shifting attention to the timing and pace of future increases.

A Reuters poll showed economists projecting the BOJ to raise rates to 1.25% in the fourth quarter after a hike in June to 1%.

One complication for investors will be comparing the language of Ueda's past comments with that of Deputy Governor Shinichi Uchida, who holds next week's post-meeting briefing on the governor's behalf.

Investors will be looking for clues from Uchida on whether signs of broadening inflation could prod the BOJ to speed up rate hikes.

The BOJ will likely stress its resolve to keep raising rates as the energy shock, rising import costs from a weak yen and a tight labour market fan inflation risks.

But BOJ sees little need for faster or consecutive rate increases, at least for now, sources have told Reuters, citing uncertainty over the economic fallout from the Iran war.

"While Uchida is seen as among the more dovish members of the board, he'll probably try to sound fairly hawkish to avoid triggering unwelcome yen falls," said Nobuyasu Atago, chief economist at Rakuten Securities Economic Research Institute.

"It's a dilemma. The BOJ won't want to pre-commit to any timing given so much uncertainty. But sounding too cautious about the next move could weaken the yen, push up prices and heighten the risk of being behind the curve."

A hike to 1% would bring the BOJ's policy rate around the bottom of its estimated nominal 1.1%-2.5% range seen as levels deemed neutral to the economy - reason to tread cautiously.

But the slow pace of BOJ rate hikes has been blamed for weakening the yen, which is hovering around the 160-per-dollar line seen as heightening the chance of yen intervention.

TAPER PAUSE EYED

At next week's meeting, the BOJ will also review its bond taper plan, running through March next year, and lay out a new plan for fiscal 2027 and beyond.

Sources have told Reuters the BOJ will consider maintaining the current pace of bond purchases beyond next fiscal year, as it focuses on stabilising a bond market jittery from heightening inflation risks from the Middle East war.

Japan's wholesale prices rose 6.3% in May from a year earlier, accelerating at the fastest pace in three years, as firms continued to pass on rising costs from the war-induced energy shock.

The price pressure is likely to push up core consumer inflation - which has slid below the BOJ's 2% target due to the effect of government subsidies - well above 2% later this year, analysts say.

(Reporting by Leika Kihara; Editing by Sam Holmes)