TOKYO (Reuters) -The Bank of Japan cut this fiscal year's growth forecast on Friday but maintained its view the economy was headed for a moderate recovery, a sign monetary policy will be in a holding pattern for some time.

The BOJ also released an outline of its new scheme aimed at boosting funding for activities combating climate change, which will offer banks long-term loans at zero interest.

The climate scheme will be launched this year and last until fiscal 2030. The BOJ will offer funds to banks that extend green and sustainability-linked loans, as well as invest in green bonds and sustainability-linked bonds. Transition finance loans will also be applicable for the scheme.

The BOJ said it will not pay any interest incentives to banks that tap the scheme.

In fresh quarterly projections released on Friday, the BOJ said it expects the economy to expand 3.8% in the current fiscal year ending in March 2022, down from 4.0% projected in April.

But it revised up its growth forecast for next fiscal year to 2.7% from 2.4% on expectations that consumption will pick up as vaccinations accelerate.

"Japan's economy is likely to improve ... as the pandemic's impact gradually subsides due to progress in vaccinations," the BOJ said in a quarterly report.

"But the outlook is highly uncertain as domestic and overseas economies could be swayed by developments regarding the pandemic," it said.

As widely expected, the central bank left its yield curve control (YCC) target unchanged at -0.1% for short-term interest rates and 0% for 10-year bond yields at its two-day rate review that ended on Friday.

The BOJ sharply revised up its consumer inflation forecast for the current fiscal year to 0.6% from 0.1% due in large part due to recent rises in energy costs and commodities prices.

GREEN SHIFT

Separately, the BOJ also said it would start buying green bonds using its foreign reserves.

The BOJ's new green push showed it was now focusing on issues beyond the pandemic, said Capital Economics Senior Japan Economist Marcel Thieliant.

"While the Board is under no illusion that it will hit its 2% inflation target anytime soon, it has nonetheless scaled back policy support in recent months," Thieliant said.

"Indeed, the Bank has now shifted from crisis mode towards addressing long-term structural issues," he added.

A resurgence in infections has led the government to impose a new state of emergency in Olympic host city Tokyo less than two weeks before the Games, dashing policymakers' hope of a strong rebound in growth during the quarter.

Japan's economy shrank an annualized 3.9% in January-March and likely barely grew in the second quarter, as the pandemic took a toll on service spending.

Analysts polled by Reuters now expect the economy to grow 4.2% in the current quarter, lower than an estimate they made last month, due the hit from new pandemic curbs.

By Leika Kihara and Daniel Leussink, 16th July 2021. Investing.com