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Bank of Japan Deputy Governor Hirohide Yamaguchi said on Wednesday the central bank would continue to make efforts to overcome deflation and help the economy return to a sustainable growth path with price stability.
Speaking at a meeting with business leaders in Kagoshima, the central banker said the pace of Japan's recovery is likely to slow down in the coming months as the stimulus measures taken at home and abroad begin to gradually lose their impact.
But he expects the economy to regain momentum from the summer of this year led by higher exports to emerging economies.
"If judged necessary, due, for example, to economic and price developments as well as changes in financial conditions, the bank is always prepared to implement appropriate measures at an appropriate timing," assured Yamaguchi.
The comments come after Finance Minister Naoto Kan heaped more pressure on the Bank of Japan earlier in the week to do more to overcome deflation.
But Yamaguchi pointed out that the central bank has limited room for manoeuvre with interest rates already at rock-bottom.
"Monetary policy actions are constrained since interest rates cannot be reduced to below zero," he said. The Bank of Japan has kept its benchmark interest rate rooted at 0.10% for over a year.
"To overcome deflation, it is necessary to consistently continue with threapy for the fundamental cause of a demand shortage," Yamaguchi continued.
"At the same time, to avoid creating a situation in which the economy will be aggravated, it is important to act on firms so that their business sentiment will not weaken."
Last week, Kan advised the central bank to aim for a positive annual inflation target of about 1% to pull the economic out of chronic deflation.
But Bank of Japan Governor Maasaki Shirakawa dismissed the idea, saying the current policy strategy was appropriate for now.
Core consumer prices in Japan fell 1.2% on an annual basis in December - the biggest drop since the indicator began in 1970. January inflation data is due from the government on Friday, with economists anticipating a steeper 1.4% fall.
Yamaguchi said that Japan's close connections to Asia's emerging economies gives it a good opportunity to make the most of the rapid growth momentum in the region. But he stressed that domestic demand must not be neglected, especially considering the fact that Japan faces an "unprecedented"shrinkage of population in the years to come.
Japan's economy has been dogged by unemployment, deflation and a strong yen that has hurt the competitiveness of its goods in the export market.
The economy grew 1.1% between October and December after its third quarter growth was revised down to nil from 0.3%, but its inability to overturn deflation has sparked fears that growth could stall.
Deflation encourages people to hold on to their money and delay buying goods because they anticipate future falls in prices. This results in a widespread depression of demand.
The Bank of Japan has promised to keep interest rates low, but is yet to detail its plans to combat deflation.
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