By Daniel Leussink and Leika Kihara
TOKYO (Reuters) - Bank of Japan Governor Haruhiko Kuroda said cutting interest rates further into negative territory is among the bank's policy options, according to an interview with the Nikkei newspaper published on Friday.
But he stressed that if it were to ease, the BOJ must take into account the impact such a move could have on Japan's banking system and financial market functions.
"There are various things we can do, such as combining various tools or enhancing them," Kuroda said on what the BOJ could do if it were to ease again.
Cutting rates "further into the negative zone is always an option," the newspaper quoted him as saying in the interview, held on Thursday.
Kuroda said while Japan's economy was sustaining momentum to achieve the BOJ's 2% inflation target, risks surrounding the overseas economy were heightening.
"We can't rule out the possibility that conditions will deteriorate further, so we need to be vigilant mainly on developments in U.S.-China trade tensions," he said, suggesting that overseas developments will key to the BOJ's decision on whether and how quickly it could expand stimulus.
Markets are rife with speculation the BOJ could ease policy as early as this month to fend off an unwelcome yen spike that could be caused by expected monetary easing steps by the U.S. Federal Reserve and the European Central Bank.
But some BOJ policymakers are wary of ramping up stimulus due to the rising cost of prolonged easing, such as the strain years of ultra-low rates are inflicting on commercial banks.
BOJ board member Hitoshi Suzuki, a former commercial banker, said last week he did not see the need to ease more as further falls in rates could do more harm than good.
Kuroda said life insurers and pension funds have seen the return on their investments decline significantly due to falling long-term yields, which could hurt consumer sentiment.
"Yields on super-long government bonds with maturities of 20 or 30 years have fallen a bit too far," he said. "If necessary, the BOJ could review the volume and methods of its market operations" to address excessive declines in yields, he added.
Robust household spending and capital expenditure have partly offset pressure on Japan's economy from weak exports this year. It grew 1.8% in the second quarter on an annualised basis.
But the outlook remains murky as the Sino-U.S. trade dispute intensifies, and as domestic consumption is expected to slow after a sales tax hike in October.
The BOJ said in July it will ease "without hesitation" to fend off any risks to the economic recovery, heightening market expectations of near-term monetary easing.
The central bank has said it had four options if it were to ease -- deepening negative rates, cutting its long-term rate target, increasing risky asset buying and accelerating the pace of money printing.
Some analysts have said the BOJ will not opt for deeper negative rates due to strong resistance from the banking sector and the public backlash it triggered in introducing minus rates in 2016.
"If were to ease further, we will take the most appropriate step by looking at the pros, cons and side-effects such as whether the measure won't hurt financial intermediation and market functions," Kuroda said.
Under a policy dubbed yield curve control (YCC), the BOJ guides short-term rates at -0.1% and the 10-year government bond yield around 0%.
On recent declines in long-term yields, Kuroda said the BOJ won't forcefully try to bring up yields when they are driven by market forces.
But he said there are limits to how much the BOJ will allow yields to deviate from the 0% target, stressing that it will intervene to keep falling yields in check if necessary.
(Editing by David Dolan & Kim Coghill)