By Leika Kihara and Stanley White
TOKYO (Reuters) - The Bank of Japan held off on expanding monetary stimulus on Thursday, defying market expectations for action even as soft global demand, an unwelcome yen rise and weak consumption threatened to derail a fragile economic recovery.
The yen soared against the dollar and euro after the announcement, as investors unwound bets that the central bank will loosen monetary policy again.
In a quarterly review of its projections, the BOJ cut its inflation forecasts and pushed back the timing for hitting its 2 percent price target by six months. But it maintained its optimism that the world's third-largest economy will expand moderately as a trend.
"For now, the BOJ is in a wait-and-see mode to judge the effects of its negative rate policy. Eventually, I think the BOJ will lower the interest rate further into negative territory later this year, perhaps after the July (upper house) election," said Hidenobu Tokuda, senior economist at Mizuho Research Institute.
At a two-day rate review ending on Thursday, the BOJ decided to maintain its pledge to increase base money at an annual pace of 80 trillion yen ($732 billion) by a 8-1 vote.
It also left unchanged a 0.1 percent negative interest rate it applies to some of the excess reserves that financial institutions park at the BOJ by a 7-2 vote.
The dollar was down 2 percent at 109.22 yen after the policy announcement, while the euro also shed 2 percent to 123.72 yen.
In a separate move, the central bank created a 300 billion yen loan-supply programme offering funds at zero interest to financial institutions in areas hit by this month's earthquake in southern Japan.
The decision came in the wake of data that showed consumer prices slipping in March at the fastest pace in three years and household spending falling at the fastest pace in a year, adding pressure on the BOJ to do more to spur growth.
The BOJ said it now expects consumer inflation to reach 2 percent "during fiscal 2017" ending in March 2018. In the previous forecast, it expected 2 percent inflation to be achieved in the first half of fiscal 2017.
BOJ Governor Haruhiko Kuroda will hold a news conference at 3:30 p.m. (0630 GMT) to explain the policy decision.
Markets have been divided on whether the BOJ will ease, though an increasing number of investors have been shifting their bets to favour monetary action.
The BOJ has been in a bind. Many central bankers have worried about the gloomy outlook, as weakening inflation expectations and consumption cast doubt on their argument that aggressive money printing would prompt households and firms to boost spending.
But they have equally become hesitant of using their diminishing policy ammunition, having just introduced negative rates in January. Some officials have openly voiced doubts on the merits of topping up an already massive stimulus programme.
The BOJ stunned markets in January by adding negative interest rates to its massive asset-buying programme, dubbed "quantitative and qualitative easing" (QQE), to prevent external headwinds from threatening the achievement of its price goal.
But January's move has failed to boost stock prices or arrest an unwelcome yen rise, keeping the BOJ under pressure to do more to revive an economy verging on recession.
($1 = 109.3300 yen)
(Additional reporting by Tetsushi Kajimoto and Minami Funakoshi; Editing by Eric Meijer)
