Bank of Japan Governor Masaaki Shirakawa stressed on Wednesday the central bank is fully committed to continuing powerful monetary easing, but warned that central banks can only buy time for governments to pursue structural reforms.

The Bank of Japan holds its next policy review on April 27 and Shirakawa's comments signal its readiness to keep monetary policy ultra-loose and act when deemed necessary to beat deflation in the world's third-biggest economy.

He noted, however, the potential drawbacks of keeping monetary conditions too loose for too long, such as planting the seeds of asset price bubbles and financial imbalances even when inflation remains subdued.

Structural reforms must be implemented within the breathing space provided by the provision of central bank liquidity, Shirakawa said in a speech at the Foreign Policy Association, a non-profit organization on global affairs.

If complacency sets in because of improvements in market sentiment, we could be headed for a worse outcome. Time bought can equally be usefully spent or wasted, he said, drawing as an example recent developments in the euro zone's debt crisis.

Many developed economies are struggling from structural problems and Japan is no exception with its failure to adapt policies to a rapidly ageing society leading to low potential growth and a huge fiscal deficit, Shirakawa said.

Given Japanese financial markets are awash with cash, the failure of Japan to shake off deflation can mostly be explained by its deteriorating growth potential, he said.

If the Japanese economy is to extricate itself from deflation and return to a path of sustainable growth under price stability, it requires both policies aimed at enhancing growth potential and supporting monetary stimuli, Shirakawa said.

This is why the BOJ is fully committed to continuing powerful monetary easing through various measures, including keeping interest rates virtually at zero and continuing to buy assets until 1 percent consumer inflation is in sight, he said.

The BOJ has held fire on monetary policy since surprising markets in February by increasing its asset purchases and setting a 1 percent inflation target.

But sources have said it will consider easing monetary policy at its next policy review by boosting government bond purchases under its 65 trillion yen ($799 billion) asset-buying and loan program as it battles to nudge consumer prices towards its goal.

Shirakawa, who has repeatedly warned of the long-term potential side-effects of unconventional monetary stimulus, said central banks were increasingly stepping into the realm of fiscal policy by taking up various assets in huge amounts.

That could ultimately undermine the legitimacy of central bank independence and public trust in the institution, partly because of the widening gap between what the public expect from the central bank and what it can actually deliver, he said.

The time-honored reluctance of central banks to enter into quasi-fiscal measures is based on the deference of neutrality, or the need to be seen as not meddling with the allocation of resources, he said.

In this context, the unconventional policies currently implemented by central banks of major developed economies will be truly tested when central banks deem that the policies are no longer necessary, he said.

($1 = 81.3100 Japanese yen)

(Reporting by Leika Kihara; Editing by Edwina Gibbs and Ed Davies)

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