By Leika Kihara and Tetsushi Kajimoto
TOKYO (Reuters) - The Bank of Japan surprised global financial markets on Friday by expanding its massive stimulus spending in a stark admission that economic growth and inflation have not picked up as much as expected after a sales tax hike in April.
The jolt from the BOJ, which had been expected to maintain its level of asset purchases, came as the government signalled its readiness to ramp up spending to boost the economy and as the government pension fund, the world's largest, was set to increase purchases of domestic and foreign stocks.
BOJ Governor Haruhiko Kuroda portrayed the decision as a preemptive strike to keep policy on track, rather than an admission that his plan to reflate the long moribund-economy had derailed.
"We decided to expand the quantitative and qualitative easing to ensure the early achievement of our price target," he told a news conference, reaffirming the BOJ's goal of pushing consumer price inflation to 2 percent next year.
"We are in a critical moment in the effort to break free from the deflationary mindset."
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Kuroda said the BOJ's easing was unrelated to portfolio allocations by the Government Pension Investment Fund (GPIF), but the effect of the day's two major decisions means that the central bank steps up its buying of Japanese government bonds, offsetting the giant pension fund's increased sales of them.
The BOJ's decision stands in marked contrast with the Federal Reserve, which on Wednesday ended its own "quantitative easing," judging that the U.S. economy had recovered enough to dispense with the emergency flood of cash into its financial system.
In a rare split decision, the BOJ's board voted 5-4 to accelerate purchases of Japanese government bonds so that its holdings increase at an annual pace of 80 trillion yen ($723.4 billion), up by 30 trillion yen.
The central bank also said it would triple its purchases of exchange-traded funds (ETFs) and real-estate investment trusts (REITs) and buy longer-dated debt, sending Tokyo shares soaring and prompting a sharp sell-off in the yen.
"Japan's economy continues to recover moderately as a trend and it's expected to keep growing above its potential," the central bank said. "But weak domestic demand after the sales tax hike and sharp falls in oil prices are weighing on prices."
Before Friday's shock decision, Kuroda had been relentlessly optimistic that the unprecedented monetary stimulus he unleashed 18 months ago would succeed in bolstering an economic recovery and ending 15 years of falling prices.
But the world's third-largest economy has sputtered despite the BOJ's asset purchases and earlier government spending.
Most economists polled by Reuters last week had expected the central bank to ease policy further but not so soon. A majority had expected it to move early next year.
Some economists doubt that pushing even more money into the system will be effective as long as demand remains sluggish.
Still, Economy Minister Akira Amari called the BOJ's easing a timely move, saying the decision was related to but separate from Prime Minister Shinzo Abe's looming decision on whether to raise the sales tax again next October, which would help rein in hefty government debt but risk a further economic blow.
ECONOMY FLOUNDERING
In a semiannual report, the BOJ halved its growth forecast for the fiscal year to March to 0.5 percent. It slightly lowered its CPI forecast for fiscal 2014 and fiscal 2015, but still expects to meet its inflation target within the two-year timeframe it originally set out.
"This is very significant because at the most important level, it reasserts Kuroda's leadership over the policy board, which was beginning to show open dissent," said Jesper Koll, director of research at JPMorgan Securities.
"It recognises what we have known, that the real economy has been weaker than expected, weaker than forecast, and reasserts that Kuroda thinks they can do something about this."
The benchmark Nikkei stock index spiked to a 7-year high on the BOJ bombshell. It closed up 4.8 percent, building on early gains from the news of the asset-allocation changes by the Government Pension Investment Fund.
The yen tumbled, with the dollar climbing to 110.91 yen, its highest since 2008, from 109.34 before the announcement.
"It's easy money, so financials, banks and securities, and real estate stocks stand to benefit further," said Masayuki Doshida, senior market analyst at Rakuten Securities.
"Markets were worried about the state of the Japanese economy, especially with the next sales tax rise on the horizon."
In a reminder of the challenges the central bank faces, data earlier on Friday showed Japan's inflation slowed for a second straight month in September and was just half the BOJ's target of 2 percent, while job growth showed signs of peaking.
Stripping out the effects of April's sales tax hike to 8 percent from 5 percent, annual core consumer inflation was 1 percent, casting further doubt on the BOJ's argument that its 2 percent inflation target will be met next year.
"Our cabinet's stance is to make full efforts as needed" to support the economy, Amari told a regular news conference, when asked about the chance of compiling a fiscal stimulus package.
Underscoring the stark reality, household spending fell for a six straight month in September from a year earlier, while the job-availability rate eased from its 22-year high in August.
A Japanese government panel overseeing GPIF approved plans for the fund to raise its holding of domestic stocks to 25 percent of its portfolio from a current 12 percent, sources said on Friday.
The $1.2-trillion GPIF is under pressure from Abe to shift funds towards riskier, higher-yielding investments to support the fast-ageing population, and away from low-yielding JGBs.
With Abe set to decide in December whether to raise the sales tax next year to 10 percent from 8 percent, voices are growing for him to delay the planned fiscal tightening, given the economy's weakness.
Isamu Ueda, a senior official in Komeito, the junior party in Abe's coalition, said on Friday it would be difficult to press ahead with plans to raise the tax next year.
"I think conditions are severe for (raising the tax) next October," Ueda told reporters after a meeting of Komeito's economic revival council, which he heads.
"The risks will be high if we don't let the economy stabilise a bit more" from the April tax increase, he said. "If the economy relapses, this will all come to nothing. We need to be cautious in deciding this."
($1 dollar = 110.5900 Japanese yen)
(Additional reporting by Stanley White and Hitoshi Ishida; Editing by Kim Coghill)