Japan's domestic demand outpaced production capacity for first time in six years in Q1, according to Bank of Japan, a positive sign that inflation will move toward BOJ's 2% target

Cindy Allen

TOKYO , July 16, 2014 (Thomson Reuters Corp.) – * BOJ kept policy steady this week, as widely expected

* Board maintains its inflation projection

* BOJ Governor Kuroda stressed importance of tight labor market (Adds details on monetary policy)

Domestic demand in Japan outpaced production capacity for the first time in six years in January-March, the Bank of Japan said in its monthly report on Wednesday, a positive sign that inflation will move toward the central bank's 2 percent target.

A positive output gap will help the BOJ make the argument that it can meet its 2 percent price growth goal next year, as slack in the economy has been eliminated and domestic demand is outpacing production capacity.

The output gap was plus 0.6 percent of gross domestic product in January-March, turning positive for the first time since April-June 2008, when the output gap was plus 0.7 percent.

BOJ Governor Haruhiko Kuroda expressed confidence on Tuesday that inflation would hold above 1 percent even when a boost from imported energy costs fades.

The BOJ has left policy unchanged since it launched a massive stimulus drive in April last year, when it pledged to pull Japan out of chronic deflation and push up consumer price inflation to 2 percent in roughly a year from now.

There are lingering concerns that consumer spending could falter, but Kuroda and other BOJ officials have repeatedly stressed that a tight labor market and upward pressure on wages will prevent domestic demand from weakening.

The output gap - or the difference between actual and potential gross domestic product - has been showing Japanese growth falling short of its potential since 2008, when the global financial crisis saddled Japanese companies with substantial surplus capacity. (Editing by Jacqueline Wong and Eric Meijer)

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