* BOJ could deepen negative rates if yen spikes - sources
* But BOJ's ability to cut rates seen limited
* Future BOJ easing would be defensive - analyst
* Yen trading near 100/dlr psychological barrier
* Yen up 20 pct this year as a safe haven play
(Adds latest yen rate, fresh Kuroda quotes)
By Leika Kihara
TOKYO, Oct 4 The Bank of Japan would deepen
negative interest rates to thwart any sharp spikes in the yen,
which the central bank sees as an obstacle to stoking inflation
and economic growth, sources familiar with its thinking say.
While achieving its inflation target remains the BOJ's top
policy priority, the Bank's dwindling tool-kit means an abrupt
yen rise - rather than sluggish inflation - would be the more
imminent trigger for further monetary easing, the sources say.
"If excessive yen rises hurt the economy, the BOJ won't
hesitate to ease," said one of the sources. "What's important is
to sustain the economy's momentum to hit 2 percent inflation,"
said another source, referring to the Bank's inflation target.
The dollar stood around 102 yen on Tuesday, not far from the
psychological barrier of 100 that was almost breached when the
pair fell to 100.085 last week, its weakest since Aug. 26.
Despite Japan's weak economy and ultra-low rates, investors
buy the yen as a safe haven in times of global financial stress,
knowing Japan can use its huge current account surplus to pay
off its debts.
NOT MUCH ROOM
For the past three-and-a-half years, the BOJ relied on
massive injections of money into the economy to keep the yen
weaker. But last month, the BOJ switched the focus of its
stimulus programme from buying bonds and risk assets like trust
funds investing in stocks to targeting yields.
In January, the BOJ pushed interest rates on some bank
reserves with the central bank below zero, hoping real interest
rates would fall and thus stimulate consumption and investment.
But there is not much room to deepen negative rates or cut
the 10-year bond yield target below zero, given the damage such
moves could inflict on Japan's banking system.
Kuroda acknowledged on Tuesday the BOJ could be less
aggressive in expanding stimulus given the hit to financial
institutions suffering from narrowing margins.
"In guiding monetary policy, we will take into account not
just how our policies affect lending rates and the economy, but
how they affect the finance sector," he told a parliament
Analysts doubt whether the BOJ has much ammunition left to
counter yen gains driven by various external events, including
the risk the U.S. central bank may trigger a dollar fall by
delaying a rate hike now expected at the end of the year.
"The BOJ is in a tough spot because it doesn't have the
ammunition left to do aggressive easing," said Hideo Kumano, a
former central banker who is now chief economist at Dai-ichi
Life Research Institute.
"Any future easing would be defensive, not offensive, and in
response to external events like a yen spike," Kumano said.
AN "ABENOMICS" SUCCESS
BOJ Governor Haruhiko Kuroda is inclined to resort to easing
to contain rapid rises in the yen, people close to him say. His
experience battling Japan's prolonged deflation as a top finance
ministry official in the late 1990s makes him a strong believer
in the need to rein in excessive yen rises, they say.
Last week, Kuroda told business leaders in the western Japan
city of Osaka, home to electronic giants like Panasonic Corp
, the BOJ will watch yen moves with caution and take
them into account in guiding monetary policy.
Kuroda's aggressive monetary stimulus programme helped the
yen weaken nearly 40 percent in the three years to mid-2015,
when the dollar approached 126 yen, earning praise as one of the
few successes of Prime Minister Shinzo Abe's stimulus policies.
But the yen has reversed course, rising 20 percent so far
this year and weighing on corporate profits and exports.
That's making big manufacturers more pessimistic. Those
polled in the BOJ's "tankan" survey cut this fiscal year's
average dollar/yen forecast to 107.92 from 111.41 three months
The new forecast is still higher than recent levels around
100 yen, a sign corporate profits could be revised down further.
BOJ officials publicly deny their ultra-easy policy is aimed
at weakening the yen, as it would go against a Group of 20
agreement to avoid competitive currency devaluations.
One of the priorities for BOJ policymakers drafting last
month's policy overhaul was to prevent markets from boosting the
yen on expectations the bank would be withdrawing stimulus.
That was partly why the BOJ, even in shifting its policy
target to interest rates from the pace of money printing, kept a
pledge to expand its massive balance sheet by maintaining its
aggressive bond purchases, the sources said.
In a reminder to speculators not to push up the yen, the BOJ
included a reference in last month's policy statement that its
balance sheet would expand to 100 percent of the size of Japan's
economy a year from now - five times the ratio of the Federal
Reserve's and the European Central Bank's balance sheets.
"It wouldn't make much sense for the yen to rise when the
BOJ's balance sheet is so big," a central bank official said.
The decision to set a zero percent target for the 10-year
government bond yield also reflects the BOJ's view that the
Japan-U.S. yield differential for that zone tends to have a
strong influence on recent dollar/yen moves, the sources said.
(Reporting by Leika Kihara. Editing by Bill Tarrant.)