By Leika Kihara and Stanley White
TOKYO (Reuters) - The Bank of Japan said the world's third-largest economy is recovering and signaled it would increase its huge stimulus only if a planned sales tax hike was to threaten its goal of lifting inflation to 2 percent in two years.
Governor Haruhiko Kuroda said on Thursday there was no need to ease policy further now after a slew of data saw the central bank declare the economy is recovering, its most upbeat view since March 2008, before the global financial crisis.
He called on the government to proceed with the two-stage doubling of the sales tax, saying it would not derail the economy and warning that there was little fiscal and monetary policy could do once trust in Japan's finances was lost.
"It's uncertain how government bond and stock prices would react if the sales tax hike were to be delayed," Kuroda told a news conference after the BOJ's policy meeting.
"But if trust in Japan's finances is lost as a result and lead to a sharp fall in bond prices, there's no choice but to tighten fiscal policy. It's also very hard to deal with such a situation with monetary policy too," he said.
Easing the pain on the economy from the tax hike should be easier because policymakers only need to loosen fiscal and monetary stimulus further, Kuroda added.
"Even if the sales tax is raised as scheduled, we don't expect the economy to falter," he said. "If risks materialize and threaten our 2 percent inflation target, we of course will respond appropriately."
As widely expected, the central bank voted unanimously on Thursday to maintain its April pledge to increase base money, or cash and deposits at the central bank, at an annual pace of 60 trillion yen ($603 billion) to 70 trillion yen.
Kuroda's remarks come as political debate intensifies on whether to proceed with lifting the sales tax rate to 8 percent from 5 percent next April, and to 10 percent in October 2015.
The BOJ has consistently called for the need to fix Japan's tattered finances and has argued that the sales tax hike won't threaten the economic recovery or delay an end to deflation.
While critics have called for a delay or watering down of the tax hike for fear of derailing the budding recovery, the government is leaning toward proceeding as scheduled and cushioning the impact with fiscal spending.
That may add pressure on the central bank to offer further stimulus, although Kuroda said there was no need for pre-emptive action.
"We're seeing clearer signs a positive cycle of income and expenditure is kicking in for both the corporate and household sectors," Kuroda said. "Japan's economy is moving in line with our forecast."
RECOVERY TAKING HOLD
Japan emerged from recession in 2012 and data for much of this year has shown the benefits of Abe's reflationary policies and the BOJ's aggressive stimulus.
Recent data have been particularly encouraging, with the jobless rate at the lowest in almost five years, summer bonuses increasing and core consumer prices rising at the fastest pace in nearly five years.
Data on Monday showed a healthy rise in corporate capital spending, pointing to a sharp upward revision to second-quarter GDP data next week from preliminary growth of 2.6 percent.
"Japan's economy is recovering moderately," the BOJ said in a statement, revising up its assessment from August when it said the economy was "starting to recover moderately."
The BOJ's rosy assessment may heighten the case for Abe to proceed with the tax hike, a decision he will make early next month.
"The BOJ's upgrade seems appropriate because revised GDP is likely to show that capital expenditure turned positive," said Shuji Tonouchi, senior fixed income strategist at Mitsubishi UFJ Morgan Stanley Securities.
"Our main scenario is that the BOJ will ease again around the time of the first tax hike next year. There are risks from the Middle East and overseas economies, but if the BOJ eases again it will be for domestic reasons."
(Editing by John Mair)