The Bank of Japan will ease monetary policy this week and consider adopting a 2% inflation target no later than in January, sources say.
This will be its response to pressure from next Prime Minister Shinzo Abe for stronger efforts to beat deflation.
Abe's Liberal Democratic Party swept to power in Sunday's lower house election after campaigning for big fiscal spending to revive the economy and "unlimited" monetary easing to achieve higher inflation.
The country has been mired in deflation for the past 15 years.
He turned up the heat on the Bank of Japan yesterday to boost its monetary stimulus when it ends a two-day meeting on Thursday and pressing it to adopt a 2% inflation target, double its current price goal, as soon as next month.
Under pressure, the BoJ will likely ease policy this week amid looming risks to Japan's economic outlook, and may also start debating how to meet Abe's calls to set a higher price target.
Abe will form a new cabinet on December 26 and is seen choosing Taro Aso as finance minister, Japanese media said, a former prime minister and veteral lawmaker expected to toe the party's line calling for aggressive easing and public works splurge.
That means the central bank will be under pressure to respond again at its policy-setting meeting on January 21-22, when it is set to cut its economic forecast for the year ending in March 2013 due to the widening pain from slowing global growth.
The Bank of Japan now sets a 1% inflation target but has said this is a goal for the time being, and that it considers a range of zero to 2% as long-term desirable price growth. The central bank may thus opt to clarify that after the 1% inflation is met, it will aim for 2% inflation as a long-term policy goal, as a way to meet demands from Abe for more aggressive monetary stimulus.
The bank set a 1% inflation target in February and has eased monetary policy four times so far this year via an increase in its asset-buying and lending programme. But politicians like Abe have criticised the central bank for not doing enough to end 15 years of grinding deflation in Japan.
Some central bankers are keen to boost stimulus again, with the world's third-largest economy already in mild recession and unlikely to rebound strongly early next year due to weak exports to China and the potential impact from the US "fiscal cliff."
Any Bank of Japan action on Thursday will likely take the form of a further increase in its asset-buying programme. But central bankers, feeling the heat, have been privately pondering options for next year including setting a higher inflation target and buying government bonds more aggressively.
